engleski

Rating based Lévy Libor model

In this paper we consider modeling of credit risk within the Libor market models. We extend the classical definition of the default- free forward Libor rate to defaultable bonds with credit ratings and develop the rating based Libor market model. As driving processes for the dynamics of the default-free and the pre-default term structure of Libor rates time-inhomogeneous Levy processes are used. Credit migration is modeled by a conditional Markov chain, whose properties are preserved under different forward Libor measures. Conditions for absence of arbitrage in the model are derived and valuation formulae for some common credit derivatives in this setup are presented.

credit risk; ratings; time-inhomogeneous Levy process; Libor; conditional Markov chain

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