by Manfred Frühwirth of Vienna University of Economics, and
October 8, 2001
Abstract: In this article we estimate default intensities within the continuous time Jarrow/Turnbull (1995) model from daily observations of German bank bond prices, based on the default-free term structure estimated from the Svensson (1994) model provided by the Deutsche Bundesbank. Cross-sectional and time-series estimations are performed. We show that pricing errors from the term structure estimation are passed on to the Jarrow/Turnbull model and that estimated default intensities strongly depend on the estimation period and on the bond used for estimation. This result strongly supports separate estimation over cross-sectional estimation. We cannot infer a significant influence of liquidity on the default intensities. We show that the assumptions of the Jarrow/Turnbull model are not sound with the underlying data. Furthermore, we investigate the optimum volume of data required to provide reasonable estimates of the default intensity. By this we show that daily calibration need not minimize the ex-ante pricing errors. Comparisons with other literature, where default-risky term structures are estimated separately from the default-free term structure, show that even using a very simple model the pricing errors can be decreased substantially.
Keywords: Credit Risk, Intensity-based models, Jarrow/Turnbull model, Term Structure of Interest Rates.
Published in: European Journal of Finance, Vol. 12, No. 2, (February 2006), pp. 107-135.