Single and joint default in a structural model with purely discontinuous assets

Filo Fiorani, Elisa Luciano and Patrizia Semeraro

No 41, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: Structural models of credit risk are known to present both vanishing spreads at very short maturities and a poor spread fit over longer maturities. The former shortcoming, which is due to the diffusive behavior assumed for asset values, can be circumvented by considering discontinuous assets. In this paper we resort to a pure jump process of the Variance-Gamma type. First we calibrate the corresponding Merton type structural model to single-name data for the DJ CDX NA IG and CDX NA HY components. By so doing, we show that it circumvents also the diffusive structural models difficulties over longer horizons. In particular, it corrects for underprediction of low risk spreads and overprediction of high risk ones. Then we extend the model to joint default, resorting to a recent formulation of the VG multivariate model and without superimposing a copula choice. We fit default correlation for a sample of CDX NA names, using equity correlation. The main advantage of our joint model with respect to the existing non diffusive ones is that it allows calibration without the equicorrelation assumption, but still in a parsimonious way. As an example of the default assessments which the calibrated model can provide, we price a FtD swap.

Keywords: credit risk; structural models; Lévy asset prices; default probability; joint default. (search for similar items in EconPapers)
JEL-codes: G12 G32 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2007
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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