This paper reviews the literature on credit risk models. Topics included are structural and reduced form models, incomplete information, credit derivatives, and default contagion. It is argued that reduced form models and not structural models are appropriate for the pricing and hedging of...

This paper reviews the term structure of interest rates literature relating to the arbitrage-free pricing and hedging of interest rate derivatives. Term structure theory is emphasized. Topics included are the HJM model, forward and futures contracts, the expectations hypothesis, and the pricing...

Credit default swaps (CDSs) are term insurance contracts written on traded bonds. This review studies the economics of CDSs using the economics of insurance literature as a basis for analysis. It is alleged that trading in CDSs caused the 2007 credit crisis, and therefore trading CDSs is an evil...

The Nobel Prize was given to Robert C. Merton and Myron S. Scholes for discovering a new method for determining the value of an option. This is known as the Black-Merton-Scholes option pricing formula. The purpose of this essay is to explain why the Black-Merton-Scholes option pricing formula is...

This paper shows how to uniquely price non-traded assets using no-arbitrage in an otherwise friction-less market setting. The approach requires the assumption that the hedging error, properly defined, is non-priced or idiosyncratic risk. This methodology can be applied to private loans, illiquid...

This paper investigates the forecasting accuracy of bankruptcy hazard rate models for U.S. companies over the time period 1962 - 1999 using both yearly and monthly observation intervals. The contribution of this paper is multiple-fold. One, using an expanded bankruptcy database we validate the...

Taking the term structure of Treasury securities and Eurodollar rates as exogenous, this paper provides an integrated approach to the pricing and hedging of LIBOR derivatives. Our approach allows the spread between Eurodollar and Treasury rates to reflect both the credit risk in holding...

This paper formally incorporates parameter uncertainty and model error into the estimation of contingent claim models and the formulation of forecasts. This allows inference on functions of interest (option values, bias functions, hedge ratios) consistent with uncertainty in both parameters and...

This paper provides a Markov Model for the term structure of credit risk spreads. The model is based on Jarrow and Turnbull (1995) with the bankruptcy process following a discrete state space Markov chain in credit ratings. The parameters of this process are easily estimated using observable...