Multiple Ratings Model of Defaultable Term Structure

Posted: 4 Feb 2001

See all articles by Tomasz R. Bielecki

Tomasz R. Bielecki

Illinois Institute of Technology

Marek Rutkowski

Politechnika Warszawska

Abstract

A new approach to modeling credit risk, to valuation of defaultable debt and to pricing of credit derivatives is developed. Our approach, based on the Heath, Jarrow, and Morton (1992) methodology, uses the available information about the credit spreads combined with the available information about the recovery rates to model the intensities of credit migrations between various credit ratings classes. This results in a conditionally Markovian model of credit risk. We then combine our model of credit risk with a model of interest rate risk in order to derive an arbitrage-free model of defaultable bonds. As expected, the market price processes of interest rate risk and credit risk provide a natural connection between the actual and the martingale probabilities.

Suggested Citation

Bielecki, Tomasz R. and Rutkowski, Marek, Multiple Ratings Model of Defaultable Term Structure. Available at SSRN: https://ssrn.com/abstract=242884

Tomasz R. Bielecki (Contact Author)

Illinois Institute of Technology ( email )

Department of Applied Mathematics
10 W. 32nd Street
Chicago, IL 60616
United States
312 567 3185 (Phone)
312 567 3135 (Fax)

Marek Rutkowski

Politechnika Warszawska ( email )

Pl. Politechniki 1
Institute of Mathematics
00-661 Warsaw
Poland
+48-22 660 7055 (Phone)
+48-22 625 7460 (Fax)

HOME PAGE: http://www.mini.pw.edu.pl/pol/pracownicy/m_rutkowski.htm

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
983
PlumX Metrics