Default risk analysis for a firm is important for pricing corporate bonds and credit derivatives ... more Default risk analysis for a firm is important for pricing corporate bonds and credit derivatives and also helps banks to manage the risk involved in their loan portfolios. In the firm value model that was proposed by Black and Cox (1976), no pure jump component was considered. Therefore, it cannot explicitly explain the variation in the portfolio considering diffusion only. This paper deals with extensions to Black and Cox model proposed by Zhou (2001) which offer solutions to various shortcomings in the previous model. All the assumptions required and computation of the bond pricing, recovery rates and credit spread are also listed. Monte-Carlo simulations are performed for visualizing the ODE, company portfolio, recovery rates and calculating probability of survival by tweaking various parameters. At the end, CDS for specific firms are priced using the probability of survival as calculated by the model and are compared with the market prices. Lastly, the model is analyzed on the basis of how far it is successful in capturing the firm's portfolio and market fluctuations.
Default risk analysis for a firm is important for pricing corporate bonds and credit derivatives ... more Default risk analysis for a firm is important for pricing corporate bonds and credit derivatives and also helps banks to manage the risk involved in their loan portfolios. In the firm value model that was proposed by Black and Cox (1976), no pure jump component was considered. Therefore, it cannot explicitly explain the variation in the portfolio considering diffusion only. This paper deals with extensions to Black and Cox model proposed by Zhou (2001) which offer solutions to various shortcomings in the previous model. All the assumptions required and computation of the bond pricing, recovery rates and credit spread are also listed. Monte-Carlo simulations are performed for visualizing the ODE, company portfolio, recovery rates and calculating probability of survival by tweaking various parameters. At the end, CDS for specific firms are priced using the probability of survival as calculated by the model and are compared with the market prices. Lastly, the model is analyzed on the basis of how far it is successful in capturing the firm's portfolio and market fluctuations.
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