Chapter 17
Pricing and Hedging with Equity-Credit Models
Equity-credit models are pricing tools designed to value both equity and credit derivatives within a unified framework. These models are based on the assumption that any equity or credit derivative product can be hedged using common tradable assets. A typical equity-credit model identifies two major risks—mark-to-market and jump-to-default—and then hedges the former using stocks and the latter using short-term credit default swap (CDS) contracts. We start with a description of a new equity-credit model that provides enough flexibility to extract information from both the equity smile and the CDS curve. We then show how linking ...
