Risk-Neutral and Actual Default Probabilities with an Endogenous Bankruptcy Jump-Diffusion Model

Asia Pacific Financial Markets, Vol. 13, p. 11-39, 2006

31 Pages Posted: 1 Mar 2006 Last revised: 4 Jun 2014

See all articles by Olivier Le Courtois

Olivier Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control

Francois Quittard-Pinon

EMLYON Business School

Date Written: February 28, 2006

Abstract

This paper focuses on historical and risk-neutral default probabilities in a structural model, when the firm assets dynamics are modeled by a double exponential jump diffusion process. Relying on the Leland [1994a, 1994b] or Leland and Toft [1996] endogenous structural approaches, as formalized by Hilberink and Rogers [2002], this article gives a coherent construction of historical default probabilities. The risk-neutral world where evolve the firm assets, modeled by a geometric Kou process, is constructed based on the Esscher measure, yielding useful and new analytical relations between historical and risk-neutral probabilities. We do a complete numerical analysis of the predictions of our framework, and compare these predictions with actual data. In particular, this new framework displays a greater predictive power than current Gaussian endogenous structural models.

Keywords: Cumulative Default Probability, Structural Model, Jump-Diffusion, Endogenous Capital Structure, Esscher Transform, Kou Processes

JEL Classification: G32, G33

Suggested Citation

Le Courtois, Olivier Arnaud and Quittard-Pinon, Francois, Risk-Neutral and Actual Default Probabilities with an Endogenous Bankruptcy Jump-Diffusion Model (February 28, 2006). Asia Pacific Financial Markets, Vol. 13, p. 11-39, 2006 . Available at SSRN: https://ssrn.com/abstract=887329

Olivier Arnaud Le Courtois

EM Lyon (Ecole de Management de Lyon) - Department of Economics, Finance, Control ( email )

23, av. Guy de Collongue
69134 Ecully Cedex
France

Francois Quittard-Pinon (Contact Author)

EMLYON Business School ( email )

23, Avenue Guy de Collongue
69134, Ecully
France

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