Template-Type: ReDIF-Paper 1.0
Title: A Libor Market Model with Default Risk 
Author-Name: Philipp J. Schönbucher 
Classification-JEL: G13 
Keywords: Default Risk, Libor Market Model, Credit Derivatives, Default Swap, Asset Swap, Default Swaption 
Abstract: In this paper a new credit risk model for credit derivatives is presented. The model 
	is based upon the ‘Libor market’ modelling framework for default-free interest rates. We model 
	effective default-free forward rates and effective forward credit spreads as lognormal diffusion 
	processes, and recovery is modelled as a fraction of the par value of the defaulted claim. The 
	newly introduced survival-based pricing measures are a valuable tool in the pricing of defaultable 
	payoffs and allow a straightforward derivation of the no-arbitrage dynamics of forward rates and 
	forward credit spreads. The model can be calibrated to the prices of defaultable coupon bonds, 
	asset swap rates and default swap rates for which closed-form solutions are given. For options 
	on default swaps and caps on credit spreads, approximate solutions of high accuracy exist. This 
	pricing formula for options on default swaps is made exact in a modified modelling framework 
	using an analogy to the swap measure, the default swap measure.
Note: 
Length: 28
Creation-Date: 2000-12
Revision-Date: 
File-URL: http://www.wiwi.uni-bonn.de/bgsepapers/bonedp/bgse15_2001.pdf
File-Format: application/pdf
Handle: RePEc:bon:bonedp:bgse15_2001