Pricing Credit Derivatives with Rating Transitions

33 Pages Posted: 3 Nov 2008

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Rangarajan K. Sundaram

New York University (NYU) - Department of Finance

Multiple version iconThere are 7 versions of this paper

Date Written: November 2001

Abstract

We develop a model for pricing risky debt and valuing credit derivatives that is easily calibrated to existing variables. Our approach is based on expanding the Das and Sundaram (2000) extension of the Heath-Jarrow-Morton (1990) term-structure model to allow for multiple ratings classes of debt. The framework has two salient features: (i) it employs a ratings transition matrix as the driver or the default process, and (ii) the entire set of rating categories is calibrated jointly, allowing arbitrage-free restrictions across rating classes, as a bond migrates amongst them. We provide an illustration of the approach by applying it to price credit-sensitive notes that have coupon payments that are linked to the rating of the underlying credit.

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Das, Sanjiv Ranjan and Sundaram, Rangarajan K., Pricing Credit Derivatives with Rating Transitions (November 2001). NYU Working Paper No. FIN-01-035, Available at SSRN: https://ssrn.com/abstract=1294580

Viral V. Acharya (Contact Author)

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Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business ( email )

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Rangarajan K. Sundaram

New York University (NYU) - Department of Finance ( email )

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