EXTENDED QUADRATIC TERM STRUCTURE MODELS FOR CREDIT RISK PRICING

Abstract

The stochastic discount factor of quadratic term structure models can be extended while retaining (quasi) closed form solutions for bonds and survival probabilities. Parameter restrictions guarantee non-negative and "well behaved" interest rates and default intensities. The extended quadratic models provide valuable new flexibility for credit risk pricing. Empirical evidence from the CDS spreads of ten diverse sovereigns shows that extended quadratic CDS pricing models outperform the classic quadratic model, since they are more general.