A Regime Switching Model for the Term Structure of Credit Risk Spreads

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We consider a rating-based model for the term structure of credit risk spreads wherein the credit-worthiness of the issuer is represented as a finite-state continuous time Markov process. This approach entails a progressive drift in credit quality towards default. A model of the economy is presented featuring stochastic transition probabilities; credit instruments are valued via an ultra parabolic Hamilton-Jacobi system of equations discretized utilizing the method-of-lines finite difference method. Computations for a callable bond are presented demonstrating the efficiency of the method.

Cite this paper

Choi, S. and Marcozzi, M. (2015) A Regime Switching Model for the Term Structure of Credit Risk Spreads. Journal of Mathematical Finance, 5, 49-57. doi: 10.4236/jmf.2015.51005.


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http://dx.doi.org/10.1080/00207160.2014.890714                                  eww150215lx


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