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Modeling Credit Risk With Partial Information

In: Financial Derivatives Pricing Selected Works of Robert Jarrow

Author

Listed:
  • UMUT ÇETIN

    (Center for Applied Mathematics, Cornell University, Ithaca, New York 14853-3801, USA)

  • ROBERT JARROW

    (Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853-3801, USA)

  • PHILIP PROTTER

    (Operations Research and Industrial Engineering Department, Cornell University, Ithaca, New York 14853-3801, USA)

  • YILDIRAY YILDIRIM

    (School of Management, Syracuse University, Syracuse, New York 13244, USA)

Abstract

This paper provides an alternative approach to Duffie and Lando [Econometrica 69 (2001) 633–664] for obtaining a reduced form credit risk model from a structural model. Duffie and Lando obtain a reduced form model by constructing an economy where the market sees the manager's information set plus noise. The noise makes default a surprise to the market. In contrast, we obtain a reduced form model by constructing an economy where the market sees a reduction of the manager's information set. The reduced information makes default a surprise to the market. We provide an explicit formula for the default intensity based on an Azéma martingale, and we use excursion theory of Brownian motions to price risky debt.

Suggested Citation

  • Umut Çetin & Robert Jarrow & Philip Protter & Yildiray Yildirim, 2008. "Modeling Credit Risk With Partial Information," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 23, pages 579-590, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812819222_0023
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    References listed on IDEAS

    as
    1. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. "Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-625, July.
    2. Robert A. Jarrow & Fan Yu, 2008. "Counterparty Risk and the Pricing of Defaultable Securities," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515, World Scientific Publishing Co. Pte. Ltd..
    3. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
    4. Philip Protter & Michael Dritschel, 1999. "Complete markets with discontinuous security price," Finance and Stochastics, Springer, vol. 3(2), pages 203-214.
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    More about this item

    Keywords

    Derivatives; Options; Hedging; HJM; Black–Scholes; Forwards; Futures; Martingale Measure; Calls; Puts; Market Manipulation; Margin Requirements;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance
    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General

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