Idiosyncratic Risk, Systematic Risk and Stochastic Volatility: An Implementation of Merton’s Credit Risk Valuation

Gatfaoui Hayette
Additional contact information
Gatfaoui Hayette: University Paris I - Panthéon-Sorbonne

Finance from EconWPA

Abstract: We extend the credit risk valuation framework introduced by Gatfaoui (2003) to stochastic volatility models. We state a general setting for valuing risky debt in the light of systematic risk and idiosyncratic risk, which are known to affect each risky asset in the financial market. The option nature of corporate debt allows then to account for the well-known volatility smile along with two documented determinants, namely stochastic volatility and market risk. Under some regularity conditions, we specify diffusion functionals leading to an asymptotically (relative to time) mean reverting volatility process. The behavior of such a specification is studied along with simulation techniques since debt is valued via a call on the firm assets value. Specifically, our examination resorts to Monte Carlo accelerators to realize related simulations. First, we consider the evolution of stochastic volatility for given parameter values. Then, we assess its impact on both risky debt and the related credit spread.

Keywords: Credit risk; credit spread; idiosyncratic risk; stochastic volatility; systematic risk. (search for similar items in EconPapers)
JEL-codes: G13 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-fin
Date: 2004-04-07
Note: Type of Document - pdf; pages: 32
View list of references

Downloads: (external link)
http://129.3.20.41/eps/fin/papers/0404/0404004.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0404004

Access Statistics for this paper

More papers in Finance from EconWPA
Series data maintained by EconWPA ().