The Jarrow/Turnbull Default Risk Model - Evidence from the German Market
by Manfred Frühwirth of Vienna University, and
October 17, 2004
Abstract: In this article we estimate default intensities within the continuous-time Jarrow and Turnbull (1995) model from German bank and corporate bond prices. We show that a joint implicit estimation of the default intensity and the recovery rate is numerically unstable. In addition to cross-sectional estimations also separate estimations (for each bond individually) are performed. Our results strongly support separate estimation over building of any cross-sections. In contrast to preceding literature, we also investigate the optimum volume of data required to provide reasonable estimates of the default intensity. By this we show that calibration based on daily data as a rule does not minimize the ex-ante mean squared pricing errors. Finally, we show that the constant default intensity assumption is not sound with the underlying data and we investigate the determinants of the default intensity. Our regressions show that the lagged default intensity estimate, the level of the default-free term structure and liquidity proxies affect the estimated default intensity via joint parameters.
Keywords: Credit risk, intensity based models, Jarrow/Turnbull model.
Published in: European Journal of Finance, Vol. 12, No. 2, (February 2006), pp. 107-135.