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Credit Risk Modeling With Misreporting and Incomplete Information

by Agostino Capponi of the California Institute of Technology, and
Jakša Cvitanić of the California Institute of Technology

February 2009

Abstract: We propose a structural model for the valuation of defaultable securities of a firm which models the effect of deliberate misreporting done by insiders in the firm and unobserved by others. We derive exact formulas for equity and bond prices and approximate expressions for the conditional default probability, recovery rate, and credit spread under the proposed credit risk framework. We propose a novel estimation approach to structural model estimation which accounts for noisy observed asset values. We apply the proposed method to calibrate a simple version of our model to the case of Parmalat and show that the model is able to recover a certain amount of misreporting during the years of accounting irregularities.

Keywords: Credit risk, incomplete information, calibration, nonlinear filtering, Parmalat, structural models.

Published in: International Journal of Theoretical and Applied Finance, Vol. 12, No. 1, (February 2009), pp. 83-112.

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