Credit Risk Pricing based on Epstein-Zin Preference
Date
2019-12-20
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Abstract
We present a consumption-based equilibrium framework for credit risk pricing in an Epstein-Zin setting. The default time is modeled as the first hitting time of a default boundary. Bond investors have imperfect information about the firm value which is unobservable. The state variables, consumption and volatility are modeled as affine diffusion processes. Using the Epstein-Zin equilibrium solution as the pricing kernel, the price of a zero-coupon bond is expressed as the solution of a system of a two-dimensional parabolic partial differential equation (PDE) which is solved numerically. The price under the imperfect information is derived based on the solution of a stochastic partial differential equation (SPDE). Finally, We analyze the implications of imperfect information and firm parameters on the yield spreads.
Description
Keywords
Epstein-Zin preference, Imperfect information, Stochastic partial differential equation
Citation
Ma, J. (2019). Credit Risk Pricing based on Epstein-Zin Preference (Master's thesis, University of Calgary, Calgary, Canada). Retrieved from https://prism.ucalgary.ca.