Structural Credit Modeling Under Stochastic Volatility

Marcos Escobar, Tim Friederich, Mikhail Krayzler, Luis Seco, Rudi Zagst

Abstract


This paper presents a structural credit model with underlying stochastic volatility, a CIR process, combining the Black/Cox framework with the Heston Model. We allow to calibrate a Heston Model for a non-observable process as underlying of the Black/Cox Model. A closed-form solution for the price of a down-and-out call option on the assets with the debt as barrier and strike price is derived using the concept of optional sampling. Furthermore, estimators are derived with the Method of Moments for Hidden Markov Chains. As an application in Statistical Finance, the default probabilities of Merrill Lynch during the financial crisis are examined.

Full Text: PDF DOI: 10.5539/ijsp.v1n1p20

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International Journal of Statistics and Probability   ISSN 1927-7032(Print)   ISSN 1927-7040(Online)

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