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Derivative Pricing Based on Time Series Models of Default Probabilities (Master's Thesis)

by Kai-Hsiang Chang of National Sun Yat-sen University, Taiwan

August 2, 2006

Abstract: In recent years, people pay much attention to derivative pricing subject to credit risk. In this paper, we proposed an autoregressive time series model of log odds ratios to price derivatives. Examples of the proposed model are given via the structural and reduced form approaches. Pricing formulae of the proposed time series models are derived for bonds and options. Furthermore, simulation studies are performed to confirm the accuracy of derived formulae.

Keywords: autoregressive, credit risk, default probabilities, derivative pricing, log odds ratios, reduced-form, structural form.

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