Pricing Credit Derivatives with Rating Transitions

Posted: 23 Oct 2001

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Rangarajan K. Sundaram

New York University (NYU) - Department of Finance

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Abstract

We present a model for pricing risky debt and valuing credit derivatives that is easily calibrated to existing variables. Our approach expands a classical term-structure modal to allow for multiple rating classes of debt. The framework has two salient features: (1) it uses a rating-transition matrix as the driver for the default process, and (2) the entire set of rating categories is calibrated jointly, which allows arbitrage-free restrictions across rating classes as a bond migrates among them. We illustrate tha approach by applying it to price credit-sensitive notes that have coupon payments linked to the rating of the underlying credit.

Keywords: Risky Debt, Rating Transitions, Credit Derivatives, Credit Sensitive Note, HJM Model

JEL Classification: G12, G13

Suggested Citation

Acharya, Viral V. and Das, Sanjiv Ranjan and Sundaram, Rangarajan K., Pricing Credit Derivatives with Rating Transitions. Financial Analysts Journal, Vol. 58, No. 3 May/June 2002. Available at SSRN: https://ssrn.com/abstract=287582

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://algo.scu.edu/~sanjivdas/

Rangarajan K. Sundaram

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

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0308 (Phone)
212-995-4233 (Fax)

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