A Hybrid Pricing Model for Contingent Claims with Credit Risk
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In this chapter we propose a hybrid pricing model for contingent claims with counterparty risk. We call the model hybrid because it borrows both from firm value models and from intensity models. Specifically, the firm value models the recovery rate while, at the same time, an intensity-based bankruptcy process determines the occurrence of default. We study the hybrid model under various assumptions with respect to the bankruptcy process and interest rates. In addition to pricing derivative securities which are subject to counterparty default risk, we propose a pricing approach for default-free options on credit-risky bonds.
KeywordsInterest Rate Option Price Credit Risk Term Structure American Option
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