RT Journal Article
SR Electronic
T1 Default Probability Dynamics in Structural Models
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 67
OP 79
DO 10.3905/jfi.2003.319354
VO 13
IS 2
A1 John Hund
YR 2003
UL https://pm-research.com/content/13/2/67.abstract
AB While much attention has been paid to the level of credit spreads, very little research has focused on the volatility dynamics implied by common models of credit risk. This article demonstrates that the structural framework for modeling credit risk implies that credit spread volatility is bounded by asset volatility, and derives a simple expression for the process followed by default probabilities. Volatility declines with time to maturity and the risk-free rate. Default probabilities exhibit a theoretical smoothness that is not an artifact of the data. Structural models also achieve maximal volatility only at very low asset values, and below the face value of the debt, and there is also limited evidence that higher-rated debt generates higher heteroscedasticity than lower-rated debt.