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Jarrow–Turnbull model

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The Jarrow–Turnbull model is a widely used "reduced-form" credit risk model. It was published in 1995 by Robert A. Jarrow and Stuart Turnbull.[1] Under the model, which returns the corporate's probability of default, bankruptcy is modeled as a statistical process. The model extends the reduced-form model of Merton (1976) [2] to a random interest rates framework.

Reduced-form models are an approach to credit risk modeling that contrasts sharply with "structural credit models", the best known of which is the Merton model of 1974. Reduced-form models focus on modeling the probability of default as a statistical process, whereas structural-models inhere a microeconomic model of the firm's capital structure, deriving the (single-period) probability of default from the random variation in the (unobservable) value of the firm's assets.[3] Large financial institutions employ default models of both the structural and reduced-form types.

See also

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References

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  1. ^ Robert A. Jarrow and Stuart Turnbull, "Pricing Derivatives on Financial Securities Subject to Credit Risk" Journal of Finance, vol. 50, March, 1995
  2. ^ Robert Merton, “Option Pricing When Underlying Stock Returns are Discontinuous” Journal of Financial Economics, 3, January–March, 1976, pp. 125–44.
  3. ^ Robert C. Merton “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,” Journal of Finance 29, 1974, pp. 449–470

Further reading

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  • Duffie, Darrell; Kenneth J. Singleton (2003). Credit Risk: Pricing, Measurement, and Management. Princeton University Press.
  • Jarrow, Robert, Donald R. van Deventer, Li Li, and Mark Mesler (2006). Kamakura Risk Information Services Technical Guide, Version 4.1. Kamakura Corporation.{{cite book}}: CS1 maint: multiple names: authors list (link)
  • Lando, David (2004). Credit Risk Modeling: Theory and Applications. Princeton University Press. ISBN 978-0-691-08929-4.
  • van Deventer; Donald R.; Kenji Imai; Mark Mesler (2004). Advanced Financial Risk Management: Tools & Techniques for Integrated Credit Risk and Interest Rate Risk Modeling. John Wiley. ISBN 978-0-470-82126-8.