This article presents a generic model for pricing financial derivatives subject to counterparty credit risk. Both unilateral and bilateral types of credit risks are considered. Our study shows that credit risk should be modeled as American style options in most cases, which require a backward induction valuation. To correct a common mistake in the literature, we emphasize that the market value ...

In this paper we present a model for the dynamic evolution of the term structure of default-free and defaultable interest rates. The model is set in the Libor market model framework but in contrast to the classical diffusion-driven setup, its dynamics are driven by a time-inhomogeneous Lévy process which allows us to better capture the real-world dynamics of credit spreads. We present necessary...

Because the contractual features of defaultable securities are usually complex and it may be difficult to find comparable securities for which to observe prices, valuation based on simple rules of thumb is often infea-sible. For example, one may have to value an interest rate swap subject to termination if one of the parties has its credit downgraded, and there are no comparable swaps that one ...

This paper presents a review of the developments in the area of credit risk. Starting in 1974, Merton developed a pricing method for a bond facing default risk, which was mainly settled in the framework of Black and Scholes (1973). Certain attempts have been made to relax the assumptions, giving rise to a class of models called structural models. A second class, called hazard rate models, was f...

This version of the paper is extremely preliminary. Please do not reproduce or send the paper to others without the permission of the authors. at Dallas for their helpful comments. We gratefully acknowledge Dan Konigsburg and Standard and Poors' for their cooperation and help and for providing us access to RatingsDirect. Abstract This paper examines the effects that hedge fund activism has on e...

This thesis consists of two studies on financial market imperfections. The first study (Chapters 2 and 3) investigates illiquidity, which is a reflection of different imperfections, and its pricing implications in the corporate bond market. The second study (Chapter 4) evaluates the impact of a short-sale ban, which is a form of financial constraints, on the equity and derivatives markets. In C...

The purpose of this article is to explain the spread between rates on corporate and government bonds. We show that expected default accounts for a surprisingly small fraction of the premium in corporate rates over treasuries. While state taxes explain a substantial portion of the difference, the remaining portion of the spread is closely related to the factors that we commonly accept as explain...