Correlated Elastic Default Barrier in Structural Credit Risk Modeling

Title: Correlated Elastic Default Barrier in Structural Credit Risk Modeling

Author: Jana B Simon, PhD.   

This paper proposes a correlated default barrier that determines sustainable asset value decline prior to debt’s maturity. It formulates the barrier as a function of a parameter reflecting in part economy-wide volatility, and in part firm-specific risk characteristics. Correlated elastic default barrier (EDB) allows for more asset value volatility at times of low systemic risk, and becomes more restrictive at times of high system-wide volatility. The proposed model for an elastic default barrier shall ultimately be used to facilitate dynamic default probability management.  

In this paper, I calibrate the model with daily closing prices of the VIX index compiled by the CBOE. The time series runs from 1/2004 to 11/2009, totaling 1478 observations. I smooth out the daily fluctuations by applying a 10-day simple moving average, and thus my final data set consists of 1469 10-day simple MA observations.