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The Impact of Persistence in Volatility over the Probability of Default

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  • Rodrigo Alfaro
  • Natán Golberger

Abstract

We evaluate the impact of persistence in volatility over the probability of default in Merton’s credit risk model. Our main conclusion is that a high degree of persistence, as it is observed in equity returns, implies a lower probability of default for those cases where firms possess a high level of leverage.

Suggested Citation

  • Rodrigo Alfaro & Natán Golberger, 2013. "The Impact of Persistence in Volatility over the Probability of Default," Working Papers Central Bank of Chile 689, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:689
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    References listed on IDEAS

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    1. Jean-Pierre Fouque & Ronnie Sircar & Knut Sølna, 2006. "Stochastic Volatility Effects on Defaultable Bonds," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(3), pages 215-244.
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    3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    4. Ke Wang & Darrell Duffie, 2004. "Multi-Period Corporate Failure Prediction With Stochastic Covariates," Econometric Society 2004 Far Eastern Meetings 747, Econometric Society.
    5. Carol Alexandra & Emese Lazar, 2005. "On The Continuous Limit of GARCH," ICMA Centre Discussion Papers in Finance icma-dp2005-13, Henley Business School, University of Reading.
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