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Pricing credit derivatives with rating transitions



Publishing details

IFA Working Paper

Publication Year



We present a model for pricing risky debt and valuing credit derivatives that is easily calibrated to existing variables. Our approach expands a classical term-structure model to allow for multiple rating classes of debt. The framework has two salient features: (1) it uses a rating-transition matrix as the driver for the default process, and (2) the entire set of rating categories is calibrated jointly, which allows arbitrage-free restrictions across rating classes as a bond migrates among them. We illustrate the approach by applying it to price credit-sensitive notes that have coupon payments linked to the rating of the underlying credit.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 335


IFA Working Paper

Available on ECCH


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