Pricing and Hedging of Credit Risk: Replication and Mean-Variance Approaches

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Pricing and Hedging of Credit Risk: Replication and Mean-Variance Approaches

by Tomasz R. Bielecki of the Illinois Institute of Technology, and
Monique Jeanblanc of the Université d'Évry Val d'Essonne, and
Marek Rutkowski of the Warsaw University of Technology

October 18, 2003

Abstract: The paper presents some methods and results related to the valuation and hedging of defaultable claims (credit-risk sensitive derivative instruments). Both the exact replication of attainable defaultable claims and the mean-variance hedging of non-attainable defaultable claims are examined. For the sake of simplicity, the general methods are then applied to simple cases of defaultable equity derivatives, rather than to the more complicated examples of real-life credit derivatives.

AMS Classification: 60H30, 91B28, 60J75, 60G44, 91B30.

Keywords: Mathematical finance, credit risk.

This paper is republished as Ch.4 in…