A Regime Switching Model for the Term Structure of Credit Risk Spreads
We consider a rating-based model for the term structure of credit risk spreads wherein the credit worthiness of the issuer is represented as a finite-state continuous time Markov process. This approach entails a progressive drift in creditquality towards default. A model of the economy is presented featuring stochastic transition probabilities; credit instruments are valued via an ultraparabolic Hamilton-Jacobi system of equations discretized utilizing the method-of-lines finite difference method. Computations for a callable bond are presented demonstrating the efficiency of the method.
Applied Mathematics | Finance and Financial Management
Marcozzi, M. D.
A Regime Switching Model for the Term Structure of Credit Risk Spreads.
Journal of Mathematical Finance, 5(1),