Thumbnail Image
Publication

Extending the Merton model with applications to credit value adjustment

Akyildirim, Erdinc
; 
Hekimoglu, A.A.
; 
Sensoy, A.
; 
Fabozzi, F.J.
Publication Date
2023-03
End of Embargo
Supervisor
Keywords
Finance, Structural credit risk, Merton model, Variance-gamma process, Credit value adjustment
Rights
© The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature 2023. This version of the article has been accepted for publication, after peer review (when applicable) and is subject to Springer Nature’s AM terms of use, but is not the Version of Record and does not reflect post-acceptance improvements, or any corrections. The Version of Record is available online at: https://doi.org/10.1007/s10479-023-05289-3.
cb
Peer-Reviewed
Yes
Open Access status
openAccess
Accepted for publication
07/03/2023
Institution
Department
Awarded
Embargo end date
Collections
Management and Law Publications
Show all metadata
Files
Thumbnail Image
Akyildirim_et_al_Annals_of_Operations_Research
Adobe PDF, 1.04 MB
Additional title
Abstract
Following the global financial crisis, the measurement of counterparty credit risk has become an essential part of the Basel III accord with credit value adjustment being one of the most prominent components of this concept. In this study, we extend the Merton structural credit risk model for counterparty credit risk calculation in the context of calculating the credit value adjustment mainly by estimating the probability of default. We improve the Merton model in a variance-convoluted-gamma environment to include default dependence between counterparties through a linear factor decomposition framework. This allows one to tackle dependence through a systematic common component. Our set-up allows for easier, faster and more accurate fitting for the credit spread. Results confirm that use of the variance-gamma-convolution clearly solves the vanishing credit spread problem for short time-to-maturity or low leverage cases compared to a Brownian motion environment and its modifications.
URI
http://hdl.handle.net/10454/19383
Version
Accepted manuscript
Citation
Akyildirim E, Hekimoglu AA, Sensoy A et al (2023) Extending the Merton model with applications to credit value adjustment. Annals of Operations Research. 326: 27-65.
Link to publisher’s version
Link to published version
Link to Version of Record
https://doi.org/10.1007/s10479-023-05289-3
Type
Article
Qualification name
Notes