An Integrated Pricing Model for Defaultable Loans and Bonds

21 Pages Posted: 5 Nov 2008

See all articles by Mario Onorato

Mario Onorato

Algorithmics

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: February 2003

Abstract

In recent years, credit risk has played a key role in risk management issues. Practitioners, academics and regulators have been fully involved in the process of developing, studying and analyzing credit risk models in order to find the elements which characterize a sound risk management system. In this paper we present an integrated model, based on a reduced pricing approach, for market and credit risk. Its main features are those of being mark to market and that the spread term structure by rating class is contingent on the seniority of debt within an arbitrage-free framework. We introduce issues such as, the integration of market and credit risk, the use of stochastic recovery rates and recovery by seniority. Moreover, we will characterize default risk by estimating migration risk through a "mortality rate", actuarial based, approach. The resultant probabilities will be the base for determining multi-period risk-neutral transition probability that allow pricing of risky debt in the trading and banking book.

Keywords: statistical simulation methods, financial risk management, credit risk measurement model, asset pricing, debt & debt management

Suggested Citation

Onorato, Mario and Altman, Edward I., An Integrated Pricing Model for Defaultable Loans and Bonds (February 2003). NYU Working Paper No. S-CDM-03-05. Available at SSRN: https://ssrn.com/abstract=1295803

Mario Onorato

Algorithmics ( email )

106 Bunhill Row
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Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

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

Stern School of Business
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New York, NY 10012-1126
United States

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