×

Pricing the risks of default. (English) Zbl 1274.91426

Summary: This paper decomposes default risk into timing and recovery risks. The two default components are explicitly priced as if they were traded in the futures market. We develop estimation strategies evaluating recovery risks and then construct implicit prices of contingent securities reflecting purely the timing risk. The models are estimated on monthly data for rates on certificates of deposit offered by institutions in the savings and loan industry, during the 1987–1991 period. Empirical results support market expectations of lower likelihoods of default after 1989.

MSC:

91G20 Derivative securities (option pricing, hedging, etc.)
91G40 Credit risk
PDFBibTeX XMLCite
Full Text: DOI

References:

[1] Artzner, Phillipe and Freddy Delbaen. (1995). ?Default Risk Insurance and Incomplete Markets,?Mathematical Finance 5, 187?195. · Zbl 0866.90047 · doi:10.1111/j.1467-9965.1995.tb00064.x
[2] Bismut, Jean-Michel. (1981).Mécanique Aléatoire, Lecture Notes in Mathematics No. 866. Berlin: Springer-Verlag.
[3] Black, Fischer and Myron Scholes. (1973). ?The Pricing Options and Corporate Liabilities,?Journal of Political Economy 81, 637?654. · Zbl 1092.91524 · doi:10.1086/260062
[4] Black, F. and J. Cox. (1976). ?Valuing Corporate Securities: Some Effects of Bond Indenture Provisions,?Journal of Finance (May), 351?367.
[5] Breiman, L. (1968).Probability. Reading, Massachusetts: Addison-Wesley. · Zbl 0174.48801
[6] Cook, D. O. and L. J. Spellman. (1996). ?Firm and Guarantor Risk, Risk Contagion, and the Interfirm Spread among Insured Deposits,?Journal of Financial and Quantitative Analysis 31, 265?281. · doi:10.2307/2331182
[7] Cooperman, E. S., W. Lee, and G. A. Wolfe. (1992). ?The 1985 Ohio Thrift Crises, The FSLIC’s Solvency and Rate Contagion for Retail CDs,?Journal of Finance 47, 919?940. · doi:10.1111/j.1540-6261.1992.tb04000.x
[8] Cox, John C., Jonathan E. Ingersoll, and Stephen A. Ross. (1985). ?A Theory of the Term Structure of Interest Rates,?Econometrica 53, 385?408. · Zbl 1274.91447 · doi:10.2307/1911242
[9] Duffie, D., M. Schroder and C. Skiadas. (1994). ?Recursive Valuation of Defaultable Securities and the Timing of Resolution of Uncertainty,? working paper, Kellogg Graduate School of Management, Northwestern University. · Zbl 0868.90008
[10] Duffie, D. and K. J. Singleton. (1996). ?Modeling Term Structures of Defaultable Bonds,? working paper, Graduate School of Business, Stanford University, Stanford, CA.
[11] Elliott, R. (1982).Stochastic Calculus and Applications. New York: Springer-Verlag. · Zbl 0503.60062
[12] Ellis, D. and M. J. Flannery. (1992). ?Does the Debt Market Assess Large Banks’ Risk,?Journal of Monetary Economics 30, 481?502. · doi:10.1016/0304-3932(92)90008-P
[13] Gorton, G. and A. M. Santomero. (1990). ?Market Discipline and Bank Subordinated Debt,?Journal of Money Credit and Banking 1, 119?128. · doi:10.2307/1992132
[14] Hannan, T. H. and G. A. Hanweck. (1988). ?Bank Insolvency Risk and the Market for Large Certificates of Deposit,?Journal of Money Credit and Banking 2, 203?212. · doi:10.2307/1992111
[15] Heath, D., R. Jarrow, and A. Morton. (1992). ?Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation,?Econometrica 60, 77?105. · Zbl 0751.90009 · doi:10.2307/2951677
[16] Jacod, J. and A. N. Shiryaev. (1987).Limit Theorems for Stochastic Processes. New York: Springer-Verlag. · Zbl 0635.60021
[17] Jarrow, R. and S. Turnbull. (1995). ?Pricing Derivatives on Financial Securities Subject to Credit Risk,?Journal of Finance 50, 53?85. · doi:10.1111/j.1540-6261.1995.tb05167.x
[18] James, C. (1988). ?The Use of Loan Sales and Standby Letters of Credit by Commercial Banks,?Journal of Monetary Economics 22, 395?422. · doi:10.1016/0304-3932(88)90005-0
[19] Judge, George, W. E. Griffiths, R. Carter Hill, Helmut Lutkepohl, and Tsoung-Chao Lee. (1985).The Theory and Practice of Econometrics. New York: John Wiley and Sons, Inc. · Zbl 0731.62155
[20] Kunita, H. (1990).Stochastic Flows and Stochastic Differential Equations. Cambridge, England: Cambridge University Press. · Zbl 0743.60052
[21] Longstaff, F. and E. Schwartz. (1995). ?A Simple Approach to Valuing Risky Fixed and Floating Rate Debt,?Journal of Finance 50, 789?819. · doi:10.1111/j.1540-6261.1995.tb04037.x
[22] Madan, D. and H. Unal. (1993). ?Pricing the Risks of Default,? working paper, University of Maryland, College Park, MD. · Zbl 1274.91426
[23] Merton, R. C. (1974). ?On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,?Journal of Finance 29, 449?470.
[24] Merton, R. C. (1977). ?On the Pricing of Contingent Claims and the Modigliani-Miller Theorem,?Journal of Financial Economics 5, 241?249. · doi:10.1016/0304-405X(77)90020-4
[25] Strahan, Philip E. (1995). ?Asset Returns and Economic Disasters: Evidence from the S&L Crisis,?Journal of Monetary Economics 36, 189?217. · doi:10.1016/0304-3932(95)01207-4
This reference list is based on information provided by the publisher or from digital mathematics libraries. Its items are heuristically matched to zbMATH identifiers and may contain data conversion errors. In some cases that data have been complemented/enhanced by data from zbMATH Open. This attempts to reflect the references listed in the original paper as accurately as possible without claiming completeness or a perfect matching.