On Hybrid Model for the Valuation of Credit Risk

This paper presents hybrid model for the valuation of credit risk. Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. It is closely tied to the potential return of investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk. Hybrid model combines the structural and intensity-based approaches. While avoiding their difficulties, it picks the best features of both approaches; the economic and intuitive appeal of the structural approach and the tractability and empirical fit of the intensity-based approach. In credit derivatives market there are quite a few securities that depend on more than one source of risk, like corporate bonds and convertible bonds, most attractive credit models should involve all these three sources of risk, and interest-rate risk. Our framework brings together these standard block.