A Markov Model for the Term Structure of Credit Risk Spreads

REVIEW OF FINANCIAL STUDIES, Vol. 10, No. 2

Posted: 2 Apr 1997

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

David Lando

Copenhagen Business School

Stuart M. Turnbull

University of Houston - C.T. Bauer College of Business

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Abstract

This paper provides a Markov model for the term structure of credit risk spreads. The model is based on Jarrow and Turnbull (1995) with the bankruptcy process following a discrete state space Markov chain in credit ratings. The parameters of this process are easily estimated using observable data. This model is useful for pricing and hedging corporate debt with imbedded options, for pricing and hedging OTC derivatives with counterparty risk, for pricing and hedging (foreign) government bonds subject to default risk (e.g., municipal bonds), for pricing and hedging credit derivatives, and for risk management.

JEL Classification: G12, G13

Suggested Citation

Jarrow, Robert A. and Lando, David and Turnbull, Stuart M., A Markov Model for the Term Structure of Credit Risk Spreads. REVIEW OF FINANCIAL STUDIES, Vol. 10, No. 2, Available at SSRN: https://ssrn.com/abstract=8245

Robert A. Jarrow (Contact Author)

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)

David Lando

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45 3815 3600 (Fax)

Stuart M. Turnbull

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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