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An Extension of the Jarrow-Lando-Turnbull Model to Random Recovery Rate

by Pietro Millossovich of the UniversitÓ degli Studi di Trieste

July 4, 2003

Abstract: We extend the Markovian rating model of Jarrow, Lando and Turnbull for pricing defaultable zero-coupon bonds and other credit sensitive instruments such as credit spread options, allowing for a stochastic recovery rate. The extension is performed by expanding the default state into multiple states to which correspond possibly different recovery rates. We analyze the extended model and generalize the calibration procedures introduced by Jarrow, Lando and Turnbull [17] and Kijima and Komoribayashi [19].

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