Author(s)

Seungmook Choi¹, Michael D. Marcozzi²

¹Department of Finance, University of Nevada Las Vegas, Las Vegas, NV, USA.
²Department of Mathematical Sciences, University of Nevada Las Vegas, Las Vegas, NV, USA.

We consider a rating-based model for the term structure of credit risk spreads wherein the credit-worthiness of the issuer is represented as a finite-state continuous time Markov process. This approach entails a progressive drift in credit quality towards default. A model of the economy is presented featuring stochastic transition probabilities; credit instruments are valued via an ultra parabolic Hamilton-Jacobi system of equations discretized utilizing the method-of-lines finite difference method. Computations for a callable bond are presented demonstrating the efficiency of the method.

Optimal Stopping, Failure Rate, Regime Switching, Credit Risk Spreads

Choi, S. and Marcozzi, M. (2015) A Regime Switching Model for the Term Structure of Credit Risk Spreads. Journal of Mathematical Finance, 5, 49-57. doi: 10.4236/jmf.2015.51005.