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Credit Derivatives and Risk Aversion
Tim Leung Johns Hopkins University, Dept of Applied Math & Statistics; Princeton University - Dept of Operations Research & Financial Engineering Ronnie Sircar Princeton University - Department of Operations Research and Financial Engineering Thaleia Zariphopoulou University of Texas at Austin - Red McCombs School of Business Advances in Econometrics Year: 2008, Vol. 22, pp. 275 - 291, 2008 Abstract: We discuss the valuation of credit derivatives in extreme regimes such as when the time-to-maturity is short, or when payoff is contingent upon a large number of defaults, as with senior tranches of collateralized debt obligations. In these cases, risk aversion may play an important role, especially when there is little liquidity, and utility-indifference valuation may apply. Specifically, we analyze how short-term yield spreads from defaultable bonds in a structural model may be raised due to investor risk aversion.
Keywords: credit risk, utility maximization, defaultable bonds, indifference price JEL Classifications: M41, M44, J33, G13 Accepted Paper SeriesDate posted: July 04, 2009 ; Last revised: July 04, 2009Suggested CitationContact Information
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