Credit Bubbles in Arbitrage Markets: The Geometric Arbitrage Approach to Credit Risk

37 Pages Posted: 28 Jun 2014 Last revised: 30 Jun 2019

Date Written: June 28, 2019

Abstract

We apply Geometric Arbitrage Theory to obtain results in mathematical finance for credit markets, which do not need stochastic differential geometry in their formulation. We obtain closed form equations involving default intensities and loss given defaults characterizing the no-free-lunch-with-vanishing-risk condition for corporate bonds, as well as the generic dynamics for credit market allowing for arbitrage possibilities. Moreover, arbitrage credit bubbles for both base credit assets and credit derivatives are explicitly computed for the market dynamics minimizing the arbitrage.

Keywords: Credit Risk, No-Free-Lunch-With-Vanishing-Risk, Geometric Arbitrage Theory, Arbitrage Credit Bubbles

JEL Classification: CO2, C62, D05, D52, D58, E43, G11, G12, G13

Suggested Citation

Farinelli, Simone and Takada, Hideyuki, Credit Bubbles in Arbitrage Markets: The Geometric Arbitrage Approach to Credit Risk (June 28, 2019). Available at SSRN: https://ssrn.com/abstract=2459369 or http://dx.doi.org/10.2139/ssrn.2459369

Simone Farinelli (Contact Author)

Core Dynamics GmbH ( email )

Scheuzerstrasse 43
Zurich, 8006
Switzerland

Hideyuki Takada

Toho University ( email )

Room 4421
Miyama 2-2-1
Funabashi, Chiba 274-8510
Japan
(+81)-47-472-1856 (Phone)

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