Three essays on credit risk modeling
by Zhu, Zhongyan, Ph.D., INDIANA UNIVERSITY, 2009, 151 pages; 3380143

Abstract:

Credit risk a general term to describe default risk of corporate firms. Credit risk is measured by credit spreads. There are two major types of credit spreads that we can observe in the financial markets: corporate bond yield spreads and credit default swap (CDS) spreads. The three-essay dissertation focuses on how to better understand credit risk from the structural approach. The first two essays focus on corporate bond spreads. The third essay focuses on CDS spreads.

The first essay is titled as Can the Performance of Structural Corporate Bond Models Be Improved? Essay one has proposed an alternative model to price risky corporate bonds with three default risk determinants. I measure default probability by three types of non-Gaussian distribution, propose two types of recovery rate, and consider both non-early default and early default. The model has improved current model performance by 50%.

The second essay is titled as Average Early Default Time and Its Contribution to Structural Models. Essay two has revealed a relationship between whether an early default is expected by the market and how to choose from two types of recovery rate based on early default expectation. Essay two sets up a connection from historical default probability, to average early default expectation, and to different recovery rates. This connection helps us empirically choose from two types of recovery rate ex ante and reduce model selection costs by 50%.

The third essay is titled as Pricing Credit Default Swaps with an Alternative Structural Measure. Essay three proposes a hybrid approach to price CDS spreads. The default probability is backed out by a reduced form model and measured by alterative structural measures proposed in Zhu (2008). This is an extension because the default probability by CDS spreads is forward looking and on the firm level. Empirical evidence shows that the majority of CDS spreads could be interpreted by firm default risk. The evidence also suggests that recovery rate be a source of risk as the default probability increases over certain level.

 
AdviserCraig W. Holden
SchoolINDIANA UNIVERSITY
SourceDAI/A 70-12, p. , Jan 2010
Source TypeDissertation
SubjectsFinance; Banking
Publication Number3380143
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