Jarrow–Turnbull model
The Jarrow–Turnbull model is a widely used "reduced-form" credit risk model. It was published in 1995 by Robert A. Jarrow and Stuart Turnbull.[1] Under the model, which returns the corporate's probability of default, bankruptcy is modeled as a statistical process. The model extends the reduced-form model of Merton (1976) [2] to a random interest rates framework.
Reduced-form models are an approach to credit risk modeling that contrasts sharply with "structural credit models", the best known of which is the Merton model of 1974. Reduced-form models focus on modeling the probability of default as a statistical process, whereas structural-models inhere a microeconomic model of the firm's capital structure, deriving the (single-period) probability of default from the random variation in the (unobservable) value of the firm's assets.[3] Large financial institutions employ default models of both the structural and reduced-form types.
See also
References
Further reading
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- ↑ Robert A. Jarrow and Stuart Turnbull, "Pricing Derivatives on Financial Securities Subject to Credit Risk" Journal of Finance, vol. 50, March, 1995
- ↑ Robert Merton, “Option Pricing When Underlying Stock Returns are Discontinuous” Journal of Financial Economics, 3, January–March, 1976, pp. 125–44.
- ↑ Robert C. Merton “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,” Journal of Finance 29, 1974, pp. 449–470