Counterparty Risk and the Pricing of Defaultable Securities

Motivated by recent financial crises in East Asia and the United States where the downfall of a small number of firms had an economy-wide impact, this paper generalizes existing reduced-form models to include default intensities dependent on the default of a counterparty. In this model, firms have c...

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Bibliographic Details
Published in:The Journal of finance (New York) 2001-10, Vol.56 (5), p.1765-1799
Main Authors: Jarrow, Robert A., Yu, Fan
Format: Article
Language:English
Subjects:
Corporate bonds
Correlation analysis
Credit risk
Default
Economic models
Financial instruments
Investment risk
Loan defaults
Pricing
Risk assessment
Securities prices
Security prices
Studies
Yield curves
Zero coupon bonds
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Summary:Motivated by recent financial crises in East Asia and the United States where the downfall of a small number of firms had an economy-wide impact, this paper generalizes existing reduced-form models to include default intensities dependent on the default of a counterparty. In this model, firms have correlated defaults due not only to an exposure to common risk factors, but also to firm-specific risks that are termed "counterparty risks." Numerical examples illustrate the effect of counter-party risk on the pricing of defaultable bonds and credit derivatives such as default swaps.
ISSN:0022-1082
1540-6261
DOI:10.1111/0022-1082.00389