Navneet Arora, Jeffrey R. Bohn and Fanlin Zhu Volume 3, Number 4, Fourth Quarter In this paper, we empirically compare two structural models (basic Merton and Vasicek- Kealhofer (VK)) and one reduced-form model (Hull-White (HW)) of credit risk. We propose here that two useful purposes for credit models are default discrimination and relative value analysis… Read more
Special Issues
Default Correlation in Reduced-Form Models
Fan Yu Volume 3, Number 4, Fourth Quarter 2005 Reduced-form models have proven to be a useful tool for analyzing the dynamics of credit spreads. However, some have recently questioned their ability to match the level of empirical default correlation. The key concern appears to be the assumption that defaults are independent conditional on the… Read more
Revisiting the Slope of the Credit Curve
David Lando and Allan Mortensen Volume 3, Number 4, Fourth Quarter 2005 The term structure of interest rates contains information about the market’s expectations of the direction of future interest rates. Similarly, the term structure of credit spreads contains information about the market’s perception of future credit spreads. The term structure of credit spreads is… Read more
SURVEY OF THE LITERATURE: Recovery Risk
Sanjiv R. Das Volume 3, Number 1, First Quarter 2005 I survey a selection of recent working papers on recovery rates, providing a framework for extant research. Simpler versions of models are also presented with a view to aid accessibility and pedagogical presentation. Despite the obvious empirical difficulties encountered with recovery rate data, modeling advances… Read more
CASE STUDIES: Betting on Management
Jack L. Treynor Volume 3, Number 1, First Quarter 2005 View PDF… Read more
Investors Like Firms That Expense Employee Stock Options and They Dislike Firms
Fayez A. Elayan, Kuntara Pukthuanthong and Richard Roll Volume 3, Number 1, First Quarter 2005 During 2002 and 2003, 140 publicly traded US firms announced their intention to recognize an accounting expense when stock options are granted to employees. Many similar firms elected not to expense options. We study the stock market’s reaction. There is… Read more
Implications of Correlated Default for Portfolio Allocation to Corporate Bonds
Mark B. Wise and Vineer Bhansali Volume 3, Number 1, First Quarter 2005 This article deals with the problem of optimal allocation of capital to corporate bonds in fixed income portfolios when there is the possibility of correlated defaults. Using a multivariate normal Copula function for the joint default probabilities we show that retaining the… Read more
Design of Financial Systems: Towards a Syntheses of Function and Structure
Robert C. Merton and Zvi Bodie Volume 3, Number 1, First Quarter 2005 This paper proposes a functional approach to designing and managing the financial systems of countries, regions, firms, households, and other entities. It is a synthesis of the neoclassical, neo-institutional, and behavioral perspectives. Neoclassical theory is an ideal driver to link science and… Read more
Asset/Liability Management and Enterprise Risk Management of an Insurer
Thomas S. Y. Ho Volume 3, Number 1, First Quarter 2005 Risk management techniques used in banks and trading floors are generally not applicable to insurance companies. Risk measures and risk monitoring approaches must be developed to respond to the challenges to the insurance industry. This paper describes the current risk management practices for both… Read more
A Markov Chain Monte Carlo Method for Derivative Pricing and Risk Assessment
Sanjiv R. Das and Alistair Sinclair Volume 3, Number 1, First Quarter 2005 Derivative security pricing and risk measurement relies increasingly on lattice representations of stochastic processes, which are a discrete approximation of the movement of the underlying securities. Pricing is undertaken by summation of node values on the lattice. When the lattice is large… Read more