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On correlated defaults and incomplete information

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  • In this paper, we study a continuous time structural asset value model for two correlated firms using a two-dimensional Brownian motion. We consider the situation of incomplete information, where the information set available to the market participants includes the default time of each firm and the periodic asset value reports. In this situation, the default time of each firm becomes a totally inaccessible stopping time to the market participants. The original structural model is first transformed to a reduced-form model. Then the conditional distribution of the default time together with the asset value of each name are derived. We prove the existence of the intensity processes of default times and also give the explicit form of the intensity processes. Numerical studies on the intensities of the two correlated names are conducted for some special cases.

    Mathematics Subject Classification: Primary: 60J65; Secondary: 65C20.

    Citation:

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  • Figure 1.  Default Intensity process $ \lambda_2 $ when $ \tau_1 = 2 $

    Figure 2.  Default Intensities of firm B where $ \rho = -0.5 $

    Figure 3.  Default Intensity Process $ \lambda_2 $ when $ \rho = 0 $

    Figure 4.  Default Intensity Process $ \lambda_2 $ when $ \tau_1 = 2 $ and $ \rho = 0.1 $

    Figure 5.  Default Intensity Process $ \lambda_2 $ when $ \tau_1 = 2 $ and $ \rho = -0.1 $

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