Ornstein-Uhlenbeck Models for Credit Risk

This work presents a reduced-form credit risk model driven by pure-jumps Ornstein-Uhlenbeck (OU) process. We analyse the case of the Gamma and Inverse Gaussian OU processes and show that the default probability can be expressed in closed-form through the characteristic function of the integrated OU process. The model is calibrated to a series of real-market credit default swap term structures. Results are compared with the well known cases of Poisson and CIR dynamics. We finally price a digital default put and show that models with pretty similar survival probabilities result in sometimes different option prices.

CARIBONI Jessica;  SCHOUTENS Wim; 

2009-06-05

Royal Flemish Academy of Belgium for Science and Arts

JRC33127

https://publications.jrc.ec.europa.eu/repository/handle/JRC33127,