We discuss the valuation of credit derivatives in extreme regimes such as when the time-to-maturity is short, or when payoff is contingent upon a large number of defaults, as with senior tranches of collateralized debt obligations. In these cases, risk aversion may play an important role, especially when there is little liquidity, and utility-indifference valuation may apply. Specifically, we analyze how short-term yield spreads from defaultable bonds in a structural model may be raised due to investor risk aversion.
Leung, T., Sircar, R. and Zariphopoulou, T. (2008), "Credit derivatives and risk aversion", Fouque, J., Fomby, T. and Solna, K. (Ed.) Econometrics and Risk Management (Advances in Econometrics, Vol. 22), Emerald Group Publishing Limited, Bingley, pp. 275-291. https://doi.org/10.1016/S0731-9053(08)22011-6Download as .RIS
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