Hedging credit derivatives when recovery rates are stochastic

Autor*innen

• Patrick Kroemer

Parameter

• Lehrbücher
• Universitätslehrbücher

Mehr zum Buch

The literature on hedging credit derivatives in continuous-time financial market models can be categorized into two model types. The first type includes tractable models that provide explicit hedge ratios but rely on unrealistic assumptions, such as deterministic interest and default rates, as well as a constant recovery rate. These assumptions do not reflect the actual variability of recovery rates in credit derivatives, which led Müller (2008) to develop the LRM-hedging strategy for stochastic recovery rates. The second type consists of models that account for stochastic variables but do not offer explicit hedge ratio representations. This work aims to bridge the gap between these two model categories with two main objectives. First, it seeks to incorporate diffusion risk into Müller’s model, deriving an explicit LRM-hedge ratio for cases with stochastic interest and default rates. Second, it aims to replace the junior bond—a defaultable zero-coupon bond—with more realistic hedging instruments such as stocks, credit default swaps, credit indices, or contingent convertible bonds. A simulation study is conducted to evaluate the performance of these various hedging instruments.

• Sprache: Englisch
• Erscheinungsdatum: 2015