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• W2183619169 abstract "We develop a convenient structural framework for the joint modeling of credit spreads, stock prices, stock options and basket credit derivatives, using a multivariate structural firm value model with skewed asset returns. We show that our setting successfully addresses several empirical facts, which are not easily accounted for in Merton’s (1974) structural model. First, stochastic volatility and left-skewed asset returns increase corporate credit spreads to more realistic levels, at short maturities and for low firm leverage. Second, our multifactor volatility structure is consistent with no-arbitrage violations relative to Merton’s model, such as positive comovement between credit spreads and stock returns. Third, our model generates endogenously a stochastic skewness of stock returns, which is a key feature for explaining the dynamics of individual option smiles. Fourth, individual implied volatility skews can be both positive and negative, depending on firm leverage and asset return skewness. Finally, the model yields realistic patterns also for implied correlation smiles of multiissuer credit derivatives, as observed in the market for CDOs, index tranches or CDS baskets. These features are obtained in a tractable matrix-valued affine diffusion setting that yields semi closed-form solutions for credit spreads, stock and credit derivative prices. ∗Fabio Trojani and Johannes Wunsch are at the University of St. Gallen. Fabio Trojani gratefully acknowledges the financial support of the Swiss National Science Foundation (NCCR FINRISK and grants 101312-103781/1 and 100012-105745/1). The usual disclaimer applies." @default.
• W2183619169 created "2016-06-24" @default.
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• W2183619169 date "2008-01-01" @default.
• W2183619169 modified "2023-09-27" @default.
• W2183619169 title "Multivariate Pricing of Capital Structure Derivatives with Stochastic Smiles and Skews" @default.
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