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Corporate Security Prices in Structural Credit Risk Models with Incomplete Information: Extended Version

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  • Ruediger Frey
  • Lars Roesler
  • Dan Lu

Abstract

The paper studies derivative asset analysis in structural credit risk models where the asset value of the firm is not fully observable. It is shown that in order to compute the price dynamics of traded securities one needs to solve a stochastic filtering problem for the asset value. We transform this problem to a filtering problem for a stopped diffusion process and we apply results from the filtering literature to this problem. In this way we obtain an SPDE-characterization for the filter density. Moreover, we characterize the default intensity under incomplete information and we determine the price dynamics of traded securities. Armed with these results we study derivative asset analysis in our setup: we explain how the model can be applied to the pricing of options on traded assets and we discuss dynamic hedging and model calibration. The paper closes with a small simulation study.

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  • Ruediger Frey & Lars Roesler & Dan Lu, 2017. "Corporate Security Prices in Structural Credit Risk Models with Incomplete Information: Extended Version," Papers 1701.04780, arXiv.org, revised May 2017.
    • Handle: RePEc:arx:papers:1701.04780
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    References listed on IDEAS

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