A Model of Credit Risk, Optimal Policies, and Asset Prices

45 Pages Posted: 21 Mar 2001

See all articles by Suleyman Basak

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Alex Shapiro

New York University (NYU) - Department of Finance

Multiple version iconThere are 5 versions of this paper

Date Written: April 2004


This article studies an economy with borrowers (firms or individuals) under costly default. Borrowers defaulting under adverse economic conditions may, despite incurring default costs, emerge as wealthier than nonborrowers. Asset substitution is generally not pronounced, although a larger risk exposure by borrowers may also occur, and then binary options emerge as useful credit derivatives. The asset-value dynamics are endogenously determined and shown to exhibit stochastic mean and volatility, in contrast to many credit risk models. In equilibrium, the market level is increased (decreased) in economic downturns (upturns) by the presence of credit risk.

JEL Classification: G33, G11, G12, C61, D51

Suggested Citation

Basak, Suleyman and Shapiro, Alex, A Model of Credit Risk, Optimal Policies, and Asset Prices (April 2004). Available at SSRN: https://ssrn.com/abstract=261868 or http://dx.doi.org/10.2139/ssrn.261868

Suleyman Basak

London Business School ( email )

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HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

United Kingdom

Alex Shapiro (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States
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212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~ashapiro/

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