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Pricing transition risk with a jump-diffusion credit risk model: evidences from the CDS market

Livieri, Giulia, Radi, Davide and Smaniotto, Elia (2024) Pricing transition risk with a jump-diffusion credit risk model: evidences from the CDS market. Review of Corporate Finance, 4 (1–2). 177 - 201. ISSN 2693-9312

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Identification Number: 10.1561/114.00000064

Abstract

Transition risk can be defined as the business-risk related to the enactment of green policies, aimed at driving the society towards a sustainable and low-carbon economy. In particular, when new green laws are released, companies are forced to comply with the new standards, incurring in costs which can undermine their financial stability. In this paper we derive formulas for the pricing of defaultable coupon bonds and Credit Default Swaps to empirically demonstrate that a jump-diffusion credit risk model in which the downward jumps in the firm value are due to tighter green laws can capture, at least partially, the transition risk. The empirical investigation consists in the model calibration on the CDS term-structure, performing a quantile regression to assess the relationship between implied prices and a proxy of the transition risk. Additionally, we show that a model without jumps lacks this property, confirming the jump-like nature of the transition risk.

Item Type: Article
Official URL: https://www.nowpublishers.com/RCF
Additional Information: © 2024 The Authors
Divisions: Statistics
Subjects: H Social Sciences > HG Finance
Q Science > QC Physics
H Social Sciences > HB Economic Theory
JEL classification: G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
C - Mathematical and Quantitative Methods > C3 - Econometric Methods: Multiple; Simultaneous Equation Models; Multiple Variables; Endogenous Regressors > C32 - Time-Series Models
C - Mathematical and Quantitative Methods > C2 - Econometric Methods: Single Equation Models; Single Variables > C21 - Cross-Sectional Models; Spatial Models; Treatment Effect Models
Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q5 - Environmental Economics > Q54 - Climate; Natural Disasters
Date Deposited: 24 May 2024 16:12
Last Modified: 20 Jul 2024 07:57
URI: http://eprints.lse.ac.uk/id/eprint/123650

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