PPT Slide
General features of the reduced form models
• describe the process for the arrival of default – unpredictable event
governed by an intensity-based or hazard rate process
• based on contingent claims methodology
(adopt the term structure modeling technique commonly used for
interest rate derivatives)
• avoid the problems associated with unobservable asset values and
complex capital structures; e.g. when the issuer is a municipal
government, then what “firm value” to use?
(however, lack a structural definition of the default event)
• reliance on credit spread data to estimate the risk neutral probability