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Article

Structural Default Modeling: A Lattice-Based Approach

George M. Jabbour, Marat V. Kramin and Stephen D. Young
The Journal of Derivatives Summer 2010, 17 (4) 44-53; DOI: https://doi.org/10.3905/jod.2010.17.4.044
George M. Jabbour
is a professor of finance and director of the MS Finance Program at George Washington University in Washington, DC.
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  • For correspondence: jabbour@gwu.edu
Marat V. Kramin
is director of Fixed Income Analytics at Wells Fargo in Charlotte, NC.
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  • For correspondence: marat.kramin@wachovia.com
Stephen D. Young
is a senior vice president and manager of the Option Strategies Group at Wells Fargo in Charlotte, NC.
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  • For correspondence: syoung@evergreeninvestments.com
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Abstract

That the stockholders’ right to default on corporate debt is an option has been understood since Merton’s seminal 1974 article. Later work by Geske and others applied Merton’s insight to more complex, and more realistic, capital structures and default criteria. Unfortunately, while it is not too hard to write down valuation equations for a firm with multiple classes of risky debt, the equations typically involve high-order multivariate normal distributions, which are quite difficult to evaluate computationally. In this article, Jabbour, Kramin, and Young propose a lattice model in which the default risk in complex capital structures becomes easier to deal with. One key to their approach is to build survival probabilities directly into the tree.

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The Journal of Derivatives: 17 (4)
The Journal of Derivatives
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Summer 2010
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Structural Default Modeling: A Lattice-Based Approach
George M. Jabbour, Marat V. Kramin, Stephen D. Young
The Journal of Derivatives May 2010, 17 (4) 44-53; DOI: 10.3905/jod.2010.17.4.044

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Structural Default Modeling: A Lattice-Based Approach
George M. Jabbour, Marat V. Kramin, Stephen D. Young
The Journal of Derivatives May 2010, 17 (4) 44-53; DOI: 10.3905/jod.2010.17.4.044
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