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Credit Bubbles in Arbitrage Markets: The Geometric Arbitrage Approach to Credit Risk

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  • Simone Farinelli
  • Hideyuki Takada

Abstract

We apply Geometric Arbitrage Theory to obtain results in mathematical finance for credit markets, which do not need stochastic differential geometry in their formulation. We obtain closed form equations involving default intensities and loss given defaults characterizing the no-free-lunch-with-vanishing-risk condition for corporate bonds, as well as the generic dynamics for credit market allowing for arbitrage possibilities. Moreover, arbitrage credit bubbles for both base credit assets and credit derivatives are explicitly computed for the market dynamics minimizing the arbitrage.

Suggested Citation

  • Simone Farinelli & Hideyuki Takada, 2014. "Credit Bubbles in Arbitrage Markets: The Geometric Arbitrage Approach to Credit Risk," Papers 1406.6805, arXiv.org, revised Jul 2021.
    • Handle: RePEc:arx:papers:1406.6805
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    1. Dupoyet, B. & Fiebig, H.R. & Musgrove, D.P., 2010. "Gauge invariant lattice quantum field theory: Implications for statistical properties of high frequency financial markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 389(1), pages 107-116.
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    4. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
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