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Counterparty Risk and the Pricing of Defaultable Securities
Author(s) -
Jarrow Robert A.,
Yu Fan
Publication year - 2001
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00389
Subject(s) - credit risk , counterparty , credit valuation adjustment , credit derivative , default , business , bond , credit default swap , credit spread (options) , actuarial science , financial economics , economics , financial system , finance , credit reference
Motivated by recent financial crises in East Asia and the United States where the downfall of a small number of firms had an economy‐wide impact, this paper generalizes existing reduced‐form models to include default intensities dependent on the default of a counterparty. In this model, firms have correlated defaults due not only to an exposure to common risk factors, but also to firm‐specific risks that are termed “counterparty risks.” Numerical examples illustrate the effect of counterparty risk on the pricing of defaultable bonds and credit derivatives such as default swaps.