Abstract
AbstractIn this article, a framework for the joint modelling of default and recovery risk is presented. The model accounts for typical characteristics known from empirical studies, e.g. negative correlation between recovery‐rate process and default intensity, as well as between default intensity and state of the economy, and a positive dependence of recovery rates on the economic environment. Within this framework analytically tractable pricing formulas for credit derivatives are derived. The stochastic model for the recovery process allows for the pricing of credit derivatives with payoffs that are directly linked to the recovery rate at default, e.g. recovery locks. Copyright © 2009 John Wiley & Sons, Ltd.
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