A Markov model for the term structure of credit risk spreads |
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Authors: | Jarrow RA; Lando D; Turnbull SM |
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Institution: | Johnson Graduate School of Management, Cornell University, Ithaca, NY 14853, USA
University of Copenhagen, Copenhagen, Denmark
Queen's University
1 Corresponding author |
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Abstract: | This article provides a Markov model for the term structureof credit risk spreads. The model is based on Jarrow and Turnbull(1995), with the bankruptcy process following a discrete statespace Markov chain in credit ratings. The parameters of thisprocess are easily estimated using observable data. This modelis useful for pricing and hedging corporate debt with imbeddedoptions, for pricing and hedging OTC derivatives with counterpartyrisk, for pricing and hedging (foreign) government bonds subjectto default risk (e.g., municipal bonds), for pricing and hedgingcredit derivatives, and for risk management. |
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