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. The Merton structural default probabilities were first offered by KMV LLC in the early 1990s. KMV LLC was acquired by Moody's Investors Service in 2002.
See also
[edit]References
[edit]- ^ 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
Further reading
[edit]- Duffie, Darrell; Kenneth J. Singleton (2003). Credit Risk: Pricing, Measurement, and Management. Princeton University Press.
- Jarrow, Robert, Donald R. van Deventer, Li Li, and Mark Mesler (2006). Kamakura Risk Information Services Technical Guide, Version 4.1. Kamakura Corporation.
{{cite book}}: CS1 maint: multiple names: authors list (link) - Lando, David (2004). Credit Risk Modeling: Theory and Applications. Princeton University Press. ISBN 978-0-691-08929-4.
- van Deventer; Donald R.; Kenji Imai; Mark Mesler (2004). Advanced Financial Risk Management: Tools & Techniques for Integrated Credit Risk and Interest Rate Risk Modeling. John Wiley. ISBN 978-0-470-82126-8.