Shape Factor Models in Credit Risk
by Philip Gisdakis of the University of Oxford
December 21, 2004
Abstract: The shape factor model is a new type of term structure model. At first developed for interest rate risk, it can be expanded to cover credit risk, as well. The term structure of interest rates or credit spreads is modelled as a linear combination of basis functions (the shape factors) weighted by stochastic coefficients. As the comparison of a principle component analysis of the time series for CDS spreads of different companies reveals, the shape factor model allows to price credit risky securities with respect to the most important underlying risk driver, specific to each counterparty.
Keywords: credit spread term structure model.