Abstract

Abstract. We extend the Markovian rating model of Jarrow, Lando and Turnbull for pricing defaultable zero-coupon bonds and other credit sensitive instruments such as credit spread options, allowing for a stochastic recovery rate. The extension is performed by expanding the default state into multiple states to which correspond possibly different recovery rates. We analyze the extended model and generalize the calibration procedures introduced by Jarrow, Lando and Turnbull [17] and Kijima and Komoribayashi [19]. Recent years have seen a dramatic growth in the total number of corporate defaults, as witnessed by empirical studies (S&P 2002 special report [7]). Moreover, since their introduction in the early 90s, the market of credit derivatives has rapidly risen to reach the size of $1189 billion and, according

Citations