DEFAULTABLE TERM STRUCTURES DRIVEN BY SEMIMARTINGALES

GÃœMBEL Sandrine () and Thorsten Schmidt
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GÃœMBEL Sandrine: Albert-Ludwigs University of Freiburg, Ernst-Zermelo-Str. 1, 79104 Freiburg, Germany
Thorsten Schmidt: Albert-Ludwigs University of Freiburg, Ernst-Zermelo-Str. 1, 79104 Freiburg, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2021, vol. 24, issue 06n07, 1-27

Abstract: In this paper, we consider a market with a term structure of credit risky bonds in the single-name case. We aim at minimal assumptions extending existing results in this direction: first, the random field of forward rates is driven by a general semimartingale. Second, the Heath–Jarrow–Morton (HJM) approach is extended with an additional component capturing those future jumps in the term structure which are visible from the current time. Third, the associated recovery scheme is as general as possible, it is only assumed to be nonincreasing. In this general setting, we derive generalized drift conditions which characterize when a given measure is a local martingale measure, thus yielding no asymptotic free lunch with vanishing risk (NAFLVR), the right notion for this large financial market to be free of arbitrage.

Keywords: Credit risk; arbitrage; HJM; forward rate; default compensator; large financial market; recovery; term structure model; stochastic discontinuities (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1142/S0219024921500321

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