The Credit Risk Pricing Researh With Random Recovery Rate

Recently, the European Sovereign Debt Crisis was going worse,Since The Greeksovereign rating was fallen down at2009, Standard&poor's, a ratingcompany,announced that cut down nine eurozone countries long-term credit rating,the European Sovereign Debt Crisis originated in Greece, has evolved the whole ofeurozone debt crisis from a single national sovereignty debt crisis,and then becamea global debt storm with restricting the global economic recovery.In the entirecrisis,the modern credit risk pricing theory revealed some shortcomings,in order toovercome them,this paper improves the credit risk pricing theory.The whole paper hassome creative works and research results as follows:(1)The modern credit risk theory mainly focus on the default process simulation,but recovery rate is only set to a constant experience value. During the2008globalfinancial crisis, the credit events triggered by the investment Banks showed thatthe recovery rate had a fall down, lead to the credit risk pricing model with fixedrecovery rate can't truthfully reflect the actual economic, so that the pricingaccuracy was insufficient, the loss of assets was be seriouslyunderestimated.Thus,the assumption that the recovery rate is a random process withcorresponding parameters could improve the modern credit risk pricing theory.(2)The default probability and recovery rate have a negative correlation,themodern credit risk pricing theory has not fully reflect the negative correlationbetween theirself. Merton (1974) proposed that the structure model reflected thenegative correlation between the default probability and the recovery rate, but inthe reduced model the negative correlation was neglected. Some experience show thatdefault probability and the recovery rate have an obvious negative correlation, andit is necessary that introducing negative correlation to the modern credit riskpricing theory.(3)The negative correlation between default probability and recovery in somespecific circumstances is the uncertainty, so the selection of uncertainty related function is very important. If the negative correlation between is certain, a certainfuction could improve the modern credit risk pricing theory.For the uncertaincorrelate function,the copula function is a good choice.(4)The pricing formula with copula function has a complexity solution,but montecarlo simulation could easily deal this problem.Monte carlo simulation methodsaccording to the mathematical statistics theory, can extract corresponding randomnumbers, and when simulation times is large, the calculation results approximatelyequal to the function values avoiding the complex solving.In a word,this paper assumes that the recovery rate is a random process,describesthe negative correlation between the default probability and recovery rate withcertain function and Copula function,improves the modern credit risk pricing theoryand proposes monte carlo simulation method for solving the result.