the web's biggest credit risk modeling resource.

Credit Jobs

Home Glossary Links FAQ / About Site Guide Search


Submit Your Paper

In Rememberance: World Trade Center (WTC)

Export citation to:
- Text (plain)
- BibTeX

Bankruptcy, Counterparty Risk, and Contagion

by Holger Kraft of the University of Kaiserslautern, and
Mogens Steffensen of the University of Copenhagen

May 5, 2006

Abstract: This paper provides a unifying framework for the modeling of various types of credit risks such as contagion effects. We argue that Markov chains can efficiently be used to tackle these problems. However, our approach is not limited to pricing problems with contagion. Other applications include the modeling of a more sophisticated default process of a firm. On the theoretical side, we derive pricing formulas for three building blocks that are generalizations of contingent claims studied in Lando (1998). These claims can be thought of as atoms forming the basis for all credit risky payments. Furthermore, we demonstrate that, in general, all contingent claims exposed to credit risk satisfy a system of partial differential equations. This is the key result to calculate prices of credit risky claims explicitly and efficiently.

JEL Classification: G13.

Keywords: default risk, financial distress, default correlation, contagion, Markov chains.

Published in: Review of Finance, Vol. 11, No. 2, (March 2007), pp. 209-252.

Books Referenced in this paper:  (what is this?)

Download paper (424K PDF) 66 pages