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The Journal of Derivatives
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The Journal of Derivatives

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Primary Article

Building Models for Credit Spreads

Angelo Arvanitis, Jonathan Gregory and Jean-Paul Laurent
The Journal of Derivatives Spring 1999, 6 (3) 27-43; DOI: https://doi.org/10.3905/jod.1999.319117
Angelo Arvanitis
Head of quantiative credit, insurance and risk research at Paribas.
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Jonathan Gregory
In Quantitative credit, insurance and risk research at Paribas.
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Jean-Paul Laurent
With CREST in Malakoff, France.
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Abstract

One standard approach to analyzing credit derivatives is to set up a Markov transition matrix describing the probabilities of moving one credit class, e.g., the Moody's bond rating, to another, and potentially to a state of default. Models based on credit migration matrices have generally been rather limited in their ability to capture real-world features of credit-sensitive instruments, such as correlation between default probabilities and interest rate movements, stochastic but correlated rate spreads between credit classes, stochastic recovery rates, and within class-yield differences that depend on whether a given bond has been upgraded or downgraded. This article presents a useful general family of credit spread models that can be set up to incorporate each of these features.

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The Journal of Derivatives
Vol. 6, Issue 3
Spring 1999
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Building Models for Credit Spreads
Angelo Arvanitis, Jonathan Gregory, Jean-Paul Laurent
The Journal of Derivatives Feb 1999, 6 (3) 27-43; DOI: 10.3905/jod.1999.319117

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Building Models for Credit Spreads
Angelo Arvanitis, Jonathan Gregory, Jean-Paul Laurent
The Journal of Derivatives Feb 1999, 6 (3) 27-43; DOI: 10.3905/jod.1999.319117
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