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research article

A General Formula for Valuing Defaultable Securities

Collin-Dufresne, P.  
•
Goldstein, R.
•
Hugonnier, J.
2004
Econometrica

Previous research has shown that under a suitable no-jump condition, the price of a defaultable security is equal to its risk-neutral expected discounted cash flows if a modified discount rate is introduced to account for the possibility of default. Below, we generalize this result by demonstrating that one can always value defaultable claims using expected risk-adjusted discounting provided that the expectation is taken under a slightly modified probability measure. This new probability measure puts zero probability on paths where default occurs prior to the maturity, and is thus only absolutely continuous with respect to the risk-neutral probability measure. After establishing the general result and discussing its relation with the existing literature, we investigate several examples for which the no-jump condition fails. Each example illustrates the power of our general formula by providing simple analytic solutions for the prices of defaultable securities.

  • Details
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Type
research article
DOI
10.1111/j.1468-0262.2004.00538.x
Author(s)
Collin-Dufresne, P.  
Goldstein, R.
Hugonnier, J.
Date Issued

2004

Published in
Econometrica
Volume

72

Issue

5

Start page

1377

End page

1407

Subjects

defaultable securities

•

risk-adjusted discounting

•

absolutely continuous change of measures

•

counterparty risk

•

flight to quality

Editorial or Peer reviewed

REVIEWED

Written at

OTHER

EPFL units
SFI-PCD  
Available on Infoscience
August 7, 2013
Use this identifier to reference this record
https://infoscience.epfl.ch/handle/20.500.14299/93991
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