Abstract:Credit risk is the distribution of ¯nancial losses due to unexpected changes in the credit quality of a counterparty in a ¯nancial agreement. We review the structural, reduced form and incomplete information ap- proaches to estimating joint default probabilities and prices of credit sensitive securities.
Contents
1 Introduction 3
2 Structural credit models 4
2.1 Classical approach . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.2 First-passage approach . . . . . . . . . . . . . . . . . . . . . . . 7
2.3 Excursion approach . . . . . . . . . . . . . . . . . . . . . . . . . 14
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2.6 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.7 Can we predict the future? . . . . . . . . . . . . . . . . . . . . . 40
3 Reduced form credit models 41
3.1 Default intensity . . . . . . . . . . . . . . . . . . . . . . . . . . 41
3.2 Rating transition intensity . . . . . . . . . . . . . . . . . . . . . 43
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3.6 Dependent defaults . . . . . . . . . . . . . . . . . . . . . . . . . 51
3.7 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
4 Incomplete information credit models 55
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4.3 Credit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
4.4 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
