The Jarrow–Turnbull model is a widely used "reduced-form"

credit risk Credit risk is the chance that a borrower does not repay a loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay ...

model. It was published in 1995 by

Robert A. Jarrow __NOTOC__ Robert Alan Jarrow is the Ronald P. and Susan E. Lynch Professor of Investment Management at the Cornell Johnson Graduate School of Management. Professor Jarrow is a co-creator of the Heath–Jarrow–Morton framework for pricing inte ...

and Stuart Turnbull. Under the model, which returns the corporate's

probability of default Probability of default (PD) is a financial term describing the likelihood of a default over a particular time horizon. It provides an estimate of the likelihood that a borrower will be unable to meet its debt obligations. PD is used in a varie ...

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the deb ...

is modeled as a statistical process. The model extends the reduced-form model of Merton (1976) to a random interest rates framework. Reduced-form models are an approach to credit risk modeling that contrasts sharply with "structural credit models", the best known of which is the

Merton model Merton may refer to: People * Merton (surname) * Merton (given name) * Merton (YouTube), American YouTube personality Fictional characters * Merton Matowski, an alternate name for "Moose" Mason, an Archie Comics character * Richard Grey, ...

of 1974. Reduced-form models focus on modeling the probability of default as a statistical process, whereas structural-models inhere a microeconomic model of the firm's

capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is detailed in the ...

, deriving the (single-period) probability of default from the random variation in the (unobservable) value of the firm's assets.

Robert C. Merton Robert Cox Merton (born July 31, 1944) is an American economist, Nobel Memorial Prize in Economic Sciences laureate, and professor at the MIT Sloan School of Management, known for his pioneering contributions to continuous-time finance, especia ...

“On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,” ''Journal of Finance'' 29, 1974, pp. 449–470 Large financial institutions employ default models of both the structural and reduced-form types.

See also

References

Further reading