Post Global Financial Crisis Modelling: Credit Risk For Firms That Are Too Big To Fail



Clark, E, Mitra, S and Jokung, O
(2019) Post Global Financial Crisis Modelling: Credit Risk For Firms That Are Too Big To Fail. International Journal of Financial Markets and Derivatives, 7 (1). 15 - 39.

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Abstract

The global financial crisis has brought in question the validity of credit risk models. The firms that are 'too big to fail' are frequently discussed in the media, and continue to borrow rather than defaulting. In this paper we propose a new credit risk model for firms that are too big to fail. We propose a structural model of credit risk but model credit risk as a real option. We derive a closed form solution for the option to default and take into account the borrowing practices of systemically important firms. We develop our model to take into account economic factors using regime switching, and derive an option pricing solution under such a process. Finally, we obtain solutions for hedging the option to default, for markets where incompleteness exists for such options. We conduct numerical experiments to calculate the option to default at different debt values and volatility.

Item Type: Article
Uncontrolled Keywords: Credit risk, Real options, Too big to fail, Financial crisis, Hedging
Depositing User: Symplectic Admin
Date Deposited: 20 Nov 2018 09:09
Last Modified: 09 Jan 2021 06:05
DOI: 10.1504/IJFMD.2019.101235
Related URLs:
URI: https://livrepository.liverpool.ac.uk/id/eprint/3014476