 Modeling and pricing credit risk with a focus on recovery riskHaibo Liu and Qihe Tang Journal of Banking & Finance, 2025, vol. 170, issue C Abstract: Consider a defaultable bond traded in a financial market that is subject to shocks and regime shifts. Its recovery payment has a hybrid structure, comprising two components: one contingent on historical information up to the time of default, and the other an independent variable indexed by the regime at the time of default. The default intensity, interest rate, and reference rate are assumed to be general deterministic functions of certain state variables, while these state variables jointly follow a jump-diffusion process, with drift and volatility coefficients governed by the regime and with jumps induced by shocks. We construct a risk-neutral pricing measure that prices all risk sources in an integrated manner. A rigorous verification of this pricing measure reveals the corresponding time-dependent market prices of these risk sources. The resulting pricing framework is applicable to most defaultable bonds and credit derivatives. Keywords: Risk-neutral pricing; Default; Shock; Regime shift; Recovery risk; Doubly stochastic Poisson process (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:170:y:2025:i:c:s0378426624002310 DOI: 10.1016/j.jbankfin.2024.107317 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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