A Markov Model For The Term Structure of Credit Risk Spreads
Robert A. Jarrow
Cornell University - Samuel Curtis Johnson Graduate School of Management
Copenhagen Business School - Department of Finance
Stuart M. Turnbull
University of Houston - C.T. Bauer College of Business
This paper provides a Markov Model for the term structure of credit risk spreads. The model is based on Jarrow and Turnbull (1995) with the bankruptcy process following a discrete state space Markov chain in credit ratings. The parameters of this process are easily estimated using observable data. This model is useful for pricing and hedging corporate debt with imbedded options, for pricing and hedging OTC derivatives with counterparty risk, for pricing and hedging (foreign) government bonds subject to default risk (e.g. municipal bonds), for pricing and hedging credit derivatives, and for risk management.
JEL Classification: G13working papers series
Date posted: September 22, 1995
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