Corporate security prices in structural credit risk models with incomplete information.

Rüdiger Frey, Lars Rösler, Dan Lu

Publication: Scientific journalJournal articlepeer-review

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Abstract

The paper studies structural credit risk models with incomplete information of the asset value. It is shown that the pricing of typical corporate securities such as equity, corporate bonds or CDSs leads to a nonlinear filtering problem. This problem cannot be tackled with standard techniques as the default time does not have an intensity under full information. We therefore transform the problem to a standard filtering problem for a stopped diffusion process. This problem is analyzed via SPDE results from the filtering literature. In particular we are able to characterize the default intensity under incomplete information in terms of the conditional density of the asset value process. Moreover, we give an explicit description of the dynamics of corporate security prices. Finally, we explain how the model can be applied to the pricing of bond and equity options and we present results from a number of numerical experiments.
Original languageEnglish
Pages (from-to)84 - 116
JournalMathematical Finance
Volume29
DOIs
Publication statusPublished - 2019

Austrian Classification of Fields of Science and Technology (ÖFOS)

  • 101024 Probability theory
  • 101007 Financial mathematics
  • 502009 Corporate finance

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