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

credit risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...

model. It was published in 1995 by Robert A. Jarrow 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 variet ...

, bankruptcy 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 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, 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. The Merton structural default probabilities were first offered by

KMV LLC Kavminvodyavia (KMV Avia) was an airline based in Mineralnye Vody in the Caucasus, Russia. It operated scheduled services to over 20 destinations in the northern Caucasus region and abroad, as well as charter services. Its main base was Mineraln ...

in the early 1990s. KMV LLC was acquired by

Moody's Investors Service Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corporation, representing the company's traditional line of business and its historical name. Moody's Investors Service provides internationa ...

in 2002.

See also

References

Further reading