A jump to default extended CEV model: an application of Bessel processes (Q854279)

The authors propose a simple framework to unify the valuation of corporate liabilities, credit derivatives, and equity derivatives by regarding them all as contingent claims on the defaultable stock. Pre-default stock dynamics under equivalent martingale measure is modeled by a time-inhomogeneous process solving a stochastic differential equation. The jump to default random time is modeled as the first time when a jump-to-default hazard process reaches certain random level. To be consistent with the leverage effect and the implied volatility, the authors specify the instantaneous volatility as that of constant elasticity of variance (CEV) process. By combining time changes, scale changes, and measure changes, they reduce the problem of determining survival probabilities, corporate bond prices, and stock option prices to one of calculating moments and truncated moments of Bessel processes evaluated at a fixed time.