CREDIT SPREADS PADA REDUCED-FORM MODEL

Abstract

There are two primary types of models in the literature that attempt to describe default processes for debt obligations and other defaultable financial instruments, usually referred to as structural and reduced-form (or intensity) models. Structural models use the evolution of firms’ structural variables, such as asset and debt values, to determine the time of default. Reduced form models do not consider the relation between default and firm value in an explicit manner. Reduced form models assume that the modeler has the same information set as the market - incomplete knowledge of the firm’s condition. that leads to an inaccessible default time. The key distinction between structural and reduced form models is not whether the default time is predictable or inaccessible, but whether the information set is observed by the market or not. Consequently, for pricing and hedging, reduced form models are the preferred methodology. Credit spreads are used to measure credit premium, which compensates risk-averse investors for assuming credit risk. Therefore, the credit spreads should remain positive. The higher credit risk assumed by the investors, the higher credit premium got be payed by them. In this paper, we have to to determine the credit spreads of reduced-form model.   Keywords: Reduced-Form Model, Hazard Rate, Credit Spreads