An Extension of CreditGrades Model Approach with Levy Processes
Quantitative Finance, Vol. 11, No. 12, 2011
Posted: 15 Nov 2008 Last revised: 27 Nov 2011
Date Written: March 12, 2010
This paper proposes an extended CreditGrades model called the Levy CreditGrades model, which is driven by a Levy process. In this setting, quasi closed-form formulae for pricing equity options to a reference firm and for calculating its survival probabilities are derived. Moreover, using three tractable Levy CreditGrades models, we compute implied volatilities on equity options and term structures of credit default swaps (CDSs) and we examine the jump risk effects of the firm's asset value on short term CDS spreads and equity volatility skew. As a result, with this extension, our model is found to have more significant abilities than the original model introduced by Finger et al.  and Stamicar and Finger , and it is more appropriate for pricing both equity and credit derivatives simultaneously.
Keywords: CreditGrades Model, Levy Process, Equity Option, Credit Default Swap, Wiener-Hopf Factorization
JEL Classification: G12, G13
Suggested Citation: Suggested Citation