Modeling the Distance-to-Default Process of a Firm
by Marco Avellaneda of New York University, and
October 26, 2001
Introduction: Credit derivatives provide synthetic protection against bond and loan default. A simple example of a credit derivative is the credit default swap, in which one counterparty makes periodic payments to another in exchange for the right to be paid a notional amount if a credit event happens. Recently, we have seen the emergence of "wholesale" credit protection in the form of first-to-default swaps written on a basket of underlying credits. Pricing of credit derivatives requires quantifying the likelihood of default of the reference entity. Default probabilities can be estimated from the spreads of the bond issued by the reference entity.
Published in: "Distance to Default", RISK, Vol. 14, No. 12, (December 2001), pp. 125-129.