An Integrated Pricing Model for Defaultable Loans and Bonds

21 Pages Posted: 23 May 2003

See all articles by Edward I. Altman

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Mario Onorato

Algorithmics

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Abstract

During the last two years, credit risk has been playing a key role in risk management issues. Practitioners, academics and regulators have been fully involved in the process of developing, studying and analysing credit risk models in order to find the elements, which characterize a sound risk management system. In this paper we present an integrated model, based on a reduced form pricing, for market and credit risk and its main features are those of being mark to market and that the spread term structure by rating class is adjusted for a spread term structure which is contingent on the seniority of debt within an arbitrage-free framework. We introduce issues such as, the integration of market and credit risk, the use of stochastic recovery rates and recovery by seniority. Moreover, we will characterise default risk by estimating migration risk through a 'mortality rate' - actuarial based - approach. The resultant probabilities will be the base for determining multi-period risk-neutral transition probability that allow to price risky debt trading and banking book plain vanilla type securities.

Keywords: statistical simulation methods, financial risk management, credit risk measurement model, pricing models, debt & debt management, portfolio choice

JEL Classification: C15, C69, H63, G11

Suggested Citation

Altman, Edward I. and Onorato, Mario, An Integrated Pricing Model for Defaultable Loans and Bonds. EFMA 2003 Helsinki Meetings; Cass Business School Research Paper. Available at SSRN: https://ssrn.com/abstract=392585 or http://dx.doi.org/10.2139/ssrn.392585

Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0709 (Phone)
212-995-4220 (Fax)

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

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

Mario Onorato

Algorithmics ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44 207 4813434 (Phone)
+ 44207 481 3130 (Fax)

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