03 05p 0 ie the implied p is 006 model parameter

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Unformatted text preview: ability to pay its debt holders. –  For a residen:al mortgage, the value of the family’s assets including the house; –  For a corporate bond, the value of company’s assets. Asset returns and default probability •  Suppose for any issuer there is a threshold such that if the value of its assets drops below the threshold, it defaults, and otherwise it does not. •  That means that, for any issuer A, there exists a return threshold αA such that if its asset return is below αA, it goes into default. •  Assume one- year return RA is Gaussian(μA,σA2) ⎛ α A − µA ⎞ P ( A defaults in 1 yr ) = P ( R...
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This note was uploaded on 05/28/2012 for the course ECE 695 taught by Professor Staff during the Spring '08 term at Purdue.

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