A Down-and-Out Exchange Option Model with Jumps to Evaluate Firms' Default Probabilities in Brazil
Claudio Henrique Barbedo
The COPPEAD Graduate School of Business at the Federal University of Rio de Janeiro (UFRJ)
Eduardo Facó Lemgruber
Universidade Federal do Rio de Janeiro (UFRJ)
October 14, 2008
We develop a tractable structural model to estimate firm's default probability by modeling its asset and debt behavior. The model is a down-and-out exchange option in a jump diffusion model. For a set of Brazilian large corporations, we compare the structural model results to the default probabilities predicted by a survival analysis applied to the Central Bank debt information database. Our model outperforms other structural models. In a last step, we use firm's sector failure probabilities to calibrate the model. This process is executed by adjusting the model jump volatility and helps to explain differences between debt and equity market failure probabilities.
Keywords: Default Probability, Equity Market, Debt Market, Option
JEL Classification: G13, G32working papers series
Date posted: October 16, 2008 ; Last revised: April 21, 2009
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