Valuation of Default-sensitive Claims under Imperfect Information

by Delia Coculescu of ETH Zürich,
Hélyette Geman of Birkbeck University & ESSEC, and
Monique Jeanblanc of the Université d'Évry Val d'Essonne & Europlace Institute of Finance

April 2008

Abstract: We propose a valuation method for financial assets subject to default risk, where investors cannot observe the state variable triggering the default but observe a correlated price process. The model is sufficiently general to encompass a large class of structural models and can be seen as a generalization of the model of Duffie and Lando (Econometrica 69:633-664, 2001). In this setting we prove that the default time is totally inaccessible in the market's filtration and derive the conditional default probabilities and the intensity process. Finally, we provide pricing formulas for default-sensitive claims and illustrate in particular examples the shapes of the credit spreads.

JEL Classification: G12, G13.

AMS Classification: 60G35, 91B29, 91B26.

Keywords: Imperfect information, Default time, Hazard process.

Published in: Finance and Stochastics, Vol. 12, No. 2, (April 2008), pp. 195-218.

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