Modeling Credit Risk by Affine Processes

Li Chen and Damir Filipovic
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Damir Filipovic: Princeton University

Finance from EconWPA

Abstract: In this paper, the treasury rates and the credit migrations are jointly modeled by multi-dimensional affine processes. In order to capture the entire information, including credit migrations and default events, we construct non-conservative regular affine processes to model credit migrations and characterize the default by the death of the processes. In particular, two specific cases: purely jump affine models and affine diffusion models with potentials, are discussed. This affine approach not only produces the explicit formulas for the prices of corporate bonds and other credit derivatives, but also directly incorporates the credit rating information as a parameter into the pricing formulas. Moreover, our affine models allow to consider the joint credit migrations within an analytically tractable framework in order to capture the correlations of credit movements between firms. Finally, the empirical testing results of a simple affine model are presented to support the effectiveness of our models.

Keywords: Credit Risk Models; Credit Migrations; Affine Processes (search for similar items in EconPapers)
JEL-codes: C39 (search for similar items in EconPapers)
Date: 2003-03-29
Note: Type of Document - pdf; prepared on IBM PC - PC-TEX/UNIX Sparc TeX; to print on HP/PostScript/Franciscan monk; pages: 25; figures: none. We never published this piece and now we would like to reduce our mailing and xerox cost by posting it.
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0303006

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