Insider trading in an equilibrium model with default: a passage from reduced-form to structural modelling |
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Authors: | Luciano Campi Umut Çetin |
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Institution: | (1) CEREMADE, Université Paris Dauphine, Place du Maréchal de Lattre de Tassigny, 75775 Paris Cedex 16, France;(2) Department of Statistics, London School of Economics, Houghton Street, London, WC2A 2AE, UK |
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Abstract: | We study, in the framework of Back Rev. Financial Stud. 5(3), 387–409 (1992)], an equilibrium model for the pricing of a defaultable zero coupon bond issued by a firm. The market consists of a risk-neutral
informed agent, noise traders, and a market maker who sets the price using the total order. When the insider does not trade,
the default time possesses a default intensity in the market’s view as in reduced-form credit risk models. However, we show
that, in equilibrium, the modelling becomes structural in the sense that the default time becomes the first time that some
continuous observation process falls below a certain barrier. Interestingly, the firm value is still not observable. We also
establish the no expected trade theorem that the insider’s trades are inconspicuous.
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Keywords: | Default Structural models Reduced-form models Equilibrium Insider trading Bessel bridge |
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