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Essays on derivatives pricing

Author: Hübner, Georges INSEAD Area: FinancePublisher: Fontainebleau : INSEAD, 1997.Language: EnglishDescription: Various pagings : Graphs ; 31 cm.Type of document: INSEAD ThesisThesis Note: For the degree of Ph.D. in management, INSEAD, May 1997Abstract: This paper presents a reduced-form model of default risk. The market value of the firm's assets, discounted by a comparable observable measure, is the state variable that affects both the arrival and the magnitude rates of default. This state variable is assumed to exhibit a mean-reverting behavior. If the occurence default leaves the investor with a fraction of her claim, corporate bonds can be priced in a two-factor Vasicek model. Under a simple capital structure, the subsequent analysis of equity reveals that its rate of return may also show mean-reversion, whose intensity is linearly related to financial leverage. Alternatively, considering that the bondholder recovers a fraction of par or of a risk-free bond when the firm defaults leads to slightly more complex pricing formulas, but in the latter case one can factorize out the price of a riskless bond. The three regimes are numerically compared in terms of yields and of sensitivity to credit risk characteristics.
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For the degree of Ph.D. in management, INSEAD, May 1997

This paper presents a reduced-form model of default risk. The market value of the firm's assets, discounted by a comparable observable measure, is the state variable that affects both the arrival and the magnitude rates of default. This state variable is assumed to exhibit a mean-reverting behavior. If the occurence default leaves the investor with a fraction of her claim, corporate bonds can be priced in a two-factor Vasicek model. Under a simple capital structure, the subsequent analysis of equity reveals that its rate of return may also show mean-reversion, whose intensity is linearly related to financial leverage. Alternatively, considering that the bondholder recovers a fraction of par or of a risk-free bond when the firm defaults leads to slightly more complex pricing formulas, but in the latter case one can factorize out the price of a riskless bond. The three regimes are numerically compared in terms of yields and of sensitivity to credit risk characteristics.

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