Credit derivatives and risk aversion

Abstract

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.

Citation

Leung, T., Sircar, R. and Zariphopoulou, T. (2008), "Credit derivatives and risk aversion", Fouque, J.-P., Fomby, T.B. and Solna, K. (Ed.) Econometrics and Risk Management (Advances in Econometrics, Vol. 22), Emerald Group Publishing Limited, Leeds, pp. 275-291. https://doi.org/10.1016/S0731-9053(08)22011-6