Reduced Form Credit Risk Models

Chapter Chapter 7 in Continuous-Time Asset Pricing Theory, 2021, pp 145-159 from Springer

Abstract: Abstract There are two models for studying credit risk. The first is called the structural approach, which was introduced by Merton (J Financ 29:449–470, 1974). This model assumes that all of the assets of the firm trade, an unrealistic assumption. Consequently, this model is best used for conceptual understanding (see Jarrow (Financ Res Lett 8:2–7, 2011) for a detailed discussion). Merton’s structural model was studied in Sect. 5.5 of Chap. 5 . The second is called the reduced form model, which was introduced by Jarrow and Turnbull (Risk Mag 5(9):63–70, 1992; J Financ 50(1):53–85, 1995). This model assumes that only a subset of the firm’s liabilities trade, those that need to be priced and hedged. This is the model studied in this chapter. This chapter is based on Jarrow (Annu Rev Financ Econ 1:37–68, 2009).

Date: 2021
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DOI: 10.1007/978-3-030-74410-6_7

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