BFC2340 Study Guide - Final Guide: Valuation Of Options, Credit Risk, Yield Spread
8 Aug 2018
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Document Summary
Credit default is rare so there isn"t as much historical data available to construct the model. Because of the diversity of corporations, it is difficult to draw any meaningful or predictive conclusions about the probability of default. There are many causes of default that makes it hard to predict. Credit risk modelling is used to measure, monitor and control a portfolio"s credit risk as well as to price credit-risky debt instruments. Credit risk models are classified as either structural models or reduced-form models. Default probability = the likelihood that a borrower will default sometime over the life of the security. To estimate the default probability, a credit risk model requires; How that info will evolve over time. A fair estimate of the credit spread for an unpriced corporate bond with a given credit rating can be estimated using a credit risk model and observed market prices. This credit spread is the fair market credit spread.
