Credit Risk : Pricing, Measurement, and Management

by Duffie, Darrell; Singleton, Kenneth J.

• ISBN13: 9781400829170
• ISBN10: 1400829178
• Copyright: 2009-08-17
• Publisher: Princeton Univ Pr

Summary

In this book, two of America's leading economists provide the first integrated treatment of the conceptual, practical, and empirical foundations for credit risk pricing and risk measurement. Masterfully applying theory to practice, Darrell Duffie and Kenneth Singleton model credit risk for the purpose of measuring portfolio risk and pricing defaultable bonds, credit derivatives, and other securities exposed to credit risk. The methodological rigor, scope, and sophistication of their state-of-the-art account is unparalleled, and its singularly in-depth treatment of pricing and credit derivatives further illuminates a problem that has drawn much attention in an era when financial institutions the world over are revising their credit management strategies. Duffie and Singleton offer critical assessments of alternative approaches to credit-risk modeling, while highlighting the strengths and weaknesses of current practice. Their approach blends in-depth discussions of the conceptual foundations of modeling with extensive analyses of the empirical properties of such credit-related time series as default probabilities, recoveries, ratings transitions, and yield spreads. Both the "structura" and "reduced-form" approaches to pricing defaultable securities are presented, and their comparative fits to historical data are assessed. The authors also provide a comprehensive treatment of the pricing of credit derivatives, including credit swaps, collateralized debt obligations, credit guarantees, lines of credit, and spread options. Not least, they describe certain enhancements to current pricing and management practices that, they argue, will better position financial institutions for future changes in the financial markets. Credit Riskis an indispensable resource for risk managers, traders or regulators dealing with financial products with a significant credit risk component, as well as for academic researchers and students.

Table of Contents

Preface	p. xi
Acknowledgments	p. xiii
Introduction	p. 1
A Brief Zoology of Risks	p. 3
Organization of Topics	p. 7
Economic Principles of Risk Management	p. 12
What Types of Risk Count Most?13
Economics of Market Risk	p. 15
Economic Principles of Credit Risk	p. 26
Risk Measurement	p. 29
Measuring Credit Risk	p. 38
Default Arrival: Historical Patterns and Statistical Models	p. 43
Introduction	p. 43
Structural Models of Default Probability	p. 53
From Theor to Practice: Using Distance to Default to Predict Default	p. 57
Default Intensity	p. 59
Examples of Intensity Models	p. 64
Default-Time Simulation	p. 72
Statistical Prediction of Bankruptcy	p. 74
Ratings Transitions: Historical Patterns and Statistical Models	p. 85
Average Transition Frequencies	p. 85
Ratings Risk and the Business Cycle	p. 87
Ratings Transitions and Aging	p. 91
Ordered Probits of Ratings	p. 92
Ratings as Markov Chains	p. 94
Conceptual Approaches to Valuation of Default Risk	p. 100
Introduction	p. 100
Risk-Neutral versus Actual Probabilities	p. 102
Reduced-Form Pricing	p. 106
Structural Models	p. 112
Comparisons of Model-Implied Spreads	p. 114
From Actual to Risk-Neutral Intensities	p. 118
Pricing Corporate and Sovereign Bonds	p. 122
Uncertain Recover	p. 122
Reduced-Form Pricing with Recover	p. 125
Ratings-Based Models of Credit Spreads	p. 137
Pricing Sovereign Bonds	p. 146
Empirical Models of Defaultable Bond Spreads	p. 156
Credit Spreads and Economic Activity	p. 156
Reference Curves for Spreads	p. 162
Parametric Reduced-Form Models	p. 166
Estimating Structural Models	p. 169
Parametric Models of Sovereign Spreads	p. 171
Credit Swaps	p. 173
Other Credit Derivatives	p. 173
The Basic Credit Swap	p. 175
Simple Credit-Swap Spreads	p. 178
Model-Based CDS Rates	p. 185
The Role of Asset Swaps	p. 190
Optional Credit Pricing	p. 194
Spread Options	p. 194
Callable and Convertible Corporate Debt	p. 201
A Simple Convertible Bond Pricing Model	p. 215
Correlated Defaults	p. 229
Alternative Approaches to Correlation	p. 229
Credit Metrics Correlated Defaults	p. 230
Correlated Default Intensities	p. 233
Copula-Based Correlation Modeling	p. 237
Empirical Methods	p. 242
Default-Time Simulation Algorithms	p. 243
Joint Default Events	p. 247
Collateralized Debt Obligations	p. 250
Introduction	p. 250
Some Economics of CDOs	p. 252
Default-Risk Model	p. 255
Pricing Examples	p. 260
Default Loss Analytics	p. 271
Computation of Diversity Scores	p. 280
Over-the-Counter Default Risk and Valuation	p. 285
Exposure	p. 285
OTC Credit Risk Value Adjustments	p. 295
Additional Swap Credit Adjustments	p. 304
Credit Spreads on Currency Swaps	p. 311
Integrated Market and Credit Risk Measurement	p. 314
Market Risk Factors	p. 315
Delta-Gamma for Derivatives with Jumps	p. 326
Integration of Market and Credit Risk	p. 332
Examples of VaR with Credit Risk	p. 334
Introduction to Affine Processes	p. 346
Econometrics of Affine Term-Structure Models	p. 362
HJM Spread Curve Models	p. 367
References	p. 371
Index	p. 385
Table of Contents provided by Publisher. All Rights Reserved.