Open AccessOn Correlation and Default Clustering in Credit Markets
Author(s) -
Antje Berndt,
Peter Ritchken,
Zhiqiang Sun
Publication year - 2010
Publication title -
review of financial studies
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 12.8
H-Index - 190
eISSN - 1465-7368
pISSN - 0893-9454
DOI - 10.1093/rfs/hhq015
Subject(s) - default , affine representation , cluster analysis , affine transformation , credit derivative , volatility (finance) , jump , interest rate , economics , econometrics , credit risk , credit default swap , itraxx , actuarial science , financial economics , computer science , credit valuation adjustment , finance , mathematics , artificial intelligence , credit reference , current algebra , physics , quantum mechanics , affine lie algebra , pure mathematics , algebra over a field
We establish Markovian models in theHeath, Jarrow, and Morton(1992) paradigm that permit an exponential affine representation of riskless and risky bond prices while offering significant flexibility in the choice of volatility structures. Estimating models in our family is typically no more difficult than in the workhorse affine family. Besides diffusive and jump-induced default correlations, defaults can impact the credit spreads of surviving firms, allowing for a greater clustering of defaults. Numerical implementations highlight the importance of incorporating interest rate--credit spread correlations, credit spread impact factors, and the full credit spread curve when building a unified framework for pricing credit derivatives. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
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