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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26735
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| Title: | A Simple Model for Pricing Securities with Equity, Interest-Rate, and
Default Risk |
| Authors: | Das, Sanjiv R.
Sundaram, Rangarajan K. |
| Issue Date: | Mar-2004 |
| Series/Report no.: | S-CDM-04-05 |
| Abstract: | We develop a model for pricing derivative and hybrid securities whose
value may depend on different sources of risk, namely, equity,
interest-rate, and default risks. In addition to valuing such securities
the framework is also useful for extracting probabilities of default
(PD) functions from market data. Our model is not based on the
stochastic process for the value of the firm [which is unobservable],
but on the stochastic process for interest rates and the equity price,
which are observable. The model comprises a risk-neutral setting in
which the joint process of interest rates and equity are modeled
together with the default conditions for security payoffs. The model is
embedded on a recombining lattice which makes implementation of the
pricing scheme feasible with polynomial complexity. We present a simple
approach to calibration of the model to market observable data. The
framework is shown to nest many familiar models as special cases. The
model is extensible to handling correlated default risk and may be used
to value distressed convertible bonds, debt-equity swaps, and credit
portfolio products such as CDOs. We present several numerical and
calibration examples to demonstrate the applicability and implementation
of our approach. |
| URI: | http://hdl.handle.net/2451/26735 |
| Appears in Collections: | Credit & Debt Markets
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