Finance and Stochastics

, Volume 11, Issue 4, pp 591–602

Insider trading in an equilibrium model with default: a passage from reduced-form to structural modelling

Article

DOI: 10.1007/s00780-007-0038-4

Cite this article as:
Campi, L. & Çetin, U. Finance Stoch (2007) 11: 591. doi:10.1007/s00780-007-0038-4

Abstract

We study, in the framework of Back [Rev. Financial Stud. 5(3), 387–409 (1992)], an equilibrium model for the pricing of a defaultable zero coupon bond issued by a firm. The market consists of a risk-neutral informed agent, noise traders, and a market maker who sets the price using the total order. When the insider does not trade, the default time possesses a default intensity in the market’s view as in reduced-form credit risk models. However, we show that, in equilibrium, the modelling becomes structural in the sense that the default time becomes the first time that some continuous observation process falls below a certain barrier. Interestingly, the firm value is still not observable. We also establish the no expected trade theorem that the insider’s trades are inconspicuous.

Keywords

Default Structural models Reduced-form models Equilibrium Insider trading Bessel bridge 

Mathematics Subject Classification (2000)

93E11 93E20 

JEL

D82 G12 

Copyright information

© Springer-Verlag 2007

Authors and Affiliations

  1. 1.CEREMADEUniversité Paris DauphineParis Cedex 16France
  2. 2.Department of StatisticsLondon School of EconomicsLondonUK

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