Corporate credit risk prediction under stochastic volatility and jumps

Di Bu and Yin Liao ()

Journal of Economic Dynamics and Control, 2014, vol. 47, issue C, 263-281

Abstract: This paper examines the impact of allowing for stochastic volatility and jumps (SVJ) in a structural model on corporate credit risk prediction. The results from a simulation study verify the better performance of the SVJ model compared with the commonly used Merton model, and three sources are provided to explain the superiority. The empirical analysis on two real samples further ascertains the importance of recognizing the stochastic volatility and jumps by showing that the SVJ model decreases bias in spread prediction from the Merton model, and better explains the time variation in actual CDS spreads. The improvements are found particularly apparent in small firms or when the market is turbulent such as the recent financial crisis.

Keywords: Credit risk; CDS spread; Merton model; Stochastic volatility; Jumps (search for similar items in EconPapers)
JEL-codes: C22 G13 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:47:y:2014:i:c:p:263-281

DOI: 10.1016/j.jedc.2014.08.006

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