Business Cycle and Credit Risk Modeling with Jump Risks

Posted: 25 Feb 2013 Last revised: 13 Aug 2016

See all articles by Bong-Gyu Jang

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Yuna Rhee

Pohang University of Science and Technology (POSTECH)

Ji Hee Yoon

University College London - Department of Economics

Date Written: February 25, 2013

Abstract

We develop a structural model that incorporates both macroeconomic risks and firm-specific jump risks. Using this model, we derive analytic formulas for default probability, equity price, and CDS spreads. We show that including the two types of risk in credit risk modeling can generate better explanations for firm's credit risks in the real world. Based on reasonably calibrated parameters, we find that our model could better predict actual default probabilities and overcome the underestimation of credit risks, especially for firms with high credit ratings, which has been one of the major limitations of the currently available structural models. The structural model proposed in this paper highlights that macroeconomic factors are important in modeling credit risks and that default probabilities, and CDS spreads could be dependent on the current economic state.

Keywords: credit risk, business cycle, jump risk, credit model, structural model, credit default swap

JEL Classification: C51, C63, E32, G33

Suggested Citation

Jang, Bong-Gyu and Rhee, Yuna and Yoon, Ji Hee, Business Cycle and Credit Risk Modeling with Jump Risks (February 25, 2013). Journal of Empirical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2223805 or http://dx.doi.org/10.2139/ssrn.2223805

Bong-Gyu Jang (Contact Author)

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Yuna Rhee

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)
+82-54-279-2978 (Phone)
+82-54-279-2870 (Fax)

Ji Hee Yoon

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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