Default Hazards and the Term Structure of Credit Spreads
in a Duopoly
Varqa Khadem, William Perraudin
Abstract
This paper shows how default hazards similar to those
suggested by the literature on reduced form credit risk models may arise
purely from the strategic behavior of indebted firms operating in a duopoly.
In so doing, our research advances attempts to reconcile structural and
reduced form approaches to modelling credit risk. In equilibrium, firm
defaults are generated endogenously by a randomly evolving intensity and
short credit spreads are strictly positive. We generalize the model to allow
for incomplete information concerning firm types and show how this leads to
default intensities that evolve in a path-dependent manner through Bayesian
learning.
Click here to
download paper (460 kB)
