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A unified approach to pricing and risk management of equity and credit risk

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  • Claudio Fontana
  • Juan Miguel A. Montes

Abstract

We propose a unified framework for equity and credit risk modeling, where the default time is a doubly stochastic random time with intensity driven by an underlying affine factor process. This approach allows for flexible interactions between the defaultable stock price, its stochastic volatility and the default intensity, while maintaining full analytical tractability. We characterise all risk-neutral measures which preserve the affine structure of the model and show that risk management as well as pricing problems can be dealt with efficiently by shifting to suitable survival measures. As an example, we consider a jump-to-default extension of the Heston stochastic volatility model.

Suggested Citation

  • Claudio Fontana & Juan Miguel A. Montes, 2012. "A unified approach to pricing and risk management of equity and credit risk," Papers 1212.5395, arXiv.org, revised May 2013.
    • Handle: RePEc:arx:papers:1212.5395
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    References listed on IDEAS

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