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Modelling bonds and credit default swaps using a structural model with contagion

[journal article]

Haworth, Helen; Reisinger, Christoph; Shaw, William

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Abstract This paper develops a two-dimensional structural framework for valuing credit default swaps and corporate bonds in the presence of default contagion. Modelling the values of related firms as correlated geometric Brownian motions with exponential default barriers, analytical formulae are obtained for both credit default swap spreads and corporate bond yields. The credit dependence structure is influenced by both a longer-term correlation structure as well as by the possibility of default contagion. In this way, the model is able to generate a diverse range of shapes for the term structure of credit spreads using realistic values for input parameters.
Classification Financial Planning, Accountancy; Economic Statistics, Econometrics, Business Informatics
Free Keywords Contagion; Correlation Modelling; Credit Models; Credit Default Swaps; Credit Risk; Defaultable Securities
Document language English
Publication Year 2008
Page/Pages p. 669-680
Journal Quantitative Finance, 8 (2008) 7
Status Postprint; peer reviewed
Licence PEER Licence Agreement (applicable only to documents from PEER project)