On Valuation with Stochastic Proportional Hazard Models in Finance

34 Pages Posted: 5 Dec 2010 Last revised: 12 Dec 2013

Akira Yamazaki

Hosei University - Graduate School of Business Administration

Date Written: September 12, 2012

Abstract

While the proportional hazard model is recognized to be statistically meaningful for analyzing and estimating financial event risks, the existing literature that analytically deals with the valuation problems is very limited. In this paper, adopting the proportional hazard model in continuous time setting, we provide an analytical treatment for the valuation problems. The derived formulas, which are based on the generalized Edgeworth expansion and give approximate solutions to the valuation problems, are widely useful for evaluating a variety of financial products such as corporate bonds, credit derivatives, mortgage-backed securities, saving accounts and time deposits. Furthermore, the formulas are applicable to the proportional hazard model having not only continuous processes (e.g., Gaussian, affine, and quadratic Gaussian processes) but also discontinuous processes (e.g., Levy and time-changed Levy processes) as stochastic covariates. Through numerical examples, it is demonstrated that very accurate values can be quickly obtained by the formulas such a closed-form formula.

Keywords: event risk, proportional hazard model, Gaussian process, affine process, quadratic Gaussian process, Levy process, time-changed Levy process

JEL Classification: G12, G13, C63

Suggested Citation

Yamazaki, Akira, On Valuation with Stochastic Proportional Hazard Models in Finance (September 12, 2012). International Journal of Theoretical and Applied Finance, Vol. 16, No. 3, 2013 . Available at SSRN: https://ssrn.com/abstract=1719080 or http://dx.doi.org/10.2139/ssrn.1719080

Akira Yamazaki (Contact Author)

Hosei University - Graduate School of Business Administration ( email )

Japan

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