Research on CDS pricing model with endogenous recovery rate

摘要

Default probability and recovery rate are two important factors in credit risk management. These factors are negatively correlated with each other. In the previous literature, it is often assumed that these factors are independent or obey specified exogenous function. This simplified approach facilitates the calculation but may affect credit risk management. This paper deduces the functional relationship between the default probability and the expected recovery rate based on the Merton's structural model, calculates the expression of default probability using the Martingale method and the Laplace transform based on a reduced approach, and constructs a CDS pricing model with an endogenous recovery rate according to the non-arbitrage pricing principle. (c) 2018 Elsevier B.V. All rights reserved.