We develop a new approach to approximating asset prices in the context of continuous-time models. For any pricing model that lacks a closed-form solution, we provide a closed-form approximate solution, which relies on the expansion of the intractable model around an “auxiliary” one. We...

The pricing formulas for European call and put options under arithmetic Brownian motion (ABM) are derived via risk-neutral valuation using the martingale measure, and checked against the corresponding Black-Scholes-like partial differential equation (PDE). In quite a few limiting cases, the...

We propose a reduced form model for default that allows us to derive closed-form solutions to all the key ingredients in credit risk modeling: risk-free bond prices, defaultable bond prices (with and without stochastic recovery) and probabilities of survival.We show that all these quantities can...

There has been increasing support in the empirical literature that both the probability of default (PD) and the loss given default (LGD) are correlated and driven by macroeconomic variables. Paradoxically, there has been very little effort from the theoretical literature to develop credit risk...

We present an empirical study of the pricing effect of liquidity in the credit default swaps (CDS) market. We construct liquidity proxies to capture various facets of CDS liquidity including adverse selection, search frictions, and inventory costs. We show that the liquidity effect on CDS...

We show that a simple equilibrium model with uncertain growth is able to simultaneously generate patterns in implied volatility and risk aversion that are similar to the ones observed in the data. In addition, the model produces an implied pricing kernel that is increasing for particular levels...

This paper assesses the impact of parameter uncertainty on corporate bondcredit spreads. Using data for 5,300 firm-years between 1994 and 2008, wefind that investors' uncertainty about model parameters explains up to 40% ofthe credit spread that is typically attributed to liquidity, taxes and...

Recently there has been some interest in the credit risk literature in models which involve stopping times related to excursions. The classical Black-Scholes-Merton-Cox approach postulates that default may occur, either at or before maturity, when the firm's value process falls below a critical...

In this contribution, we study structural models of defaultable bond pricing in which default occurs at the first time a relevant process either reaches the default boundary or has spent continuously (or cumulatively) a fixed time period below that threshold. Unlike first-passage time...

This paper investigates informed trading on stock volatility in the option market. Using a unique data set from the Chicago Board Options Exchange, we construct non-market maker net demand for stock volatility from the trading volume of individual equity options. We find that this volatility...