Estimating Expected Losses and Liquidity Discounts Implicit in Debt Prices

Journal of Risk, Vol. 5, No. 1, Fall 2002

39 Pages Posted: 6 Oct 2004 Last revised: 1 Jun 2013

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Tibor Janosi

Cornell University - Department of Computer Science; Cornell University - Samuel Curtis Johnson Graduate School of Management

Yildiray Yildirim

Zicklin School of Business, Baruch College - The City University of New York

Date Written: November 12, 2012

Abstract

This paper provides an empirical implementation of a reduced form credit risk model that incorporates both liquidity risk and correlated defaults. Liquidity risk is modeled as a convenience yield and default correlation is modeled via an intensity process that depends on market factors. Various different liquidity risk and intensity process models are investigated. Firstly, the evidence supports a non-zero liquidity premium that is firm specific, reflecting idiosyncratic and not systematic risk. Secondly, the credit risk model with correlated defaults fits the data quite well with an average R wedge 2 of .87 and a pricing error of only 1.1 percent.

Keywords: Credit Risk

Suggested Citation

Jarrow, Robert A. and Janosi, Tibor and Yildirim, Yildiray, Estimating Expected Losses and Liquidity Discounts Implicit in Debt Prices (November 12, 2012). Journal of Risk, Vol. 5, No. 1, Fall 2002. Available at SSRN: https://ssrn.com/abstract=585841

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Tibor Janosi

Cornell University - Department of Computer Science ( email )

4130 Upson Hall
Ithaca, NY 14853
United States

Cornell University - Samuel Curtis Johnson Graduate School of Management

Ithaca, NY 14853
United States

Yildiray Yildirim (Contact Author)

Zicklin School of Business, Baruch College - The City University of New York ( email )

55 Lexington Ave., Box B13-260
New York, NY 10010
United States

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