Closed form
- Thread starter higaurav
- Start date
Hi OM,
Very short version, two different sets:
1. Closed form (a.k.a., analytic. Same for our purposes) versus Numerical
2. Structural versus reduced form
Closed form/analytical = we can solve with a formula; e.g., Black-scholes, parametric VaR
Numerical = we cannot use a formula; i.e.,. we must simulate. For example, historical simulation VaR, monte carlo
Classic example: Black-Scholes is closed form (we have a formula) versus binomial (we brute force a simulation in the open lattice)
Structural versus reduced form implies the credit risk models. See credit risk models de Servigny.
Merton model for PD is structural; i.e., based on balance sheet structure (assets, debt), by variable within (endogenous) to the company. And indeed, the merton is "analytic" or closed form, as above.
Reduced form does not explain PD with company-specific variables, no cause-and-effect to expain the default. Is in "actuarial" model; e.g., CreditRisk+
David
Very short version, two different sets:
1. Closed form (a.k.a., analytic. Same for our purposes) versus Numerical
2. Structural versus reduced form
Closed form/analytical = we can solve with a formula; e.g., Black-scholes, parametric VaR
Numerical = we cannot use a formula; i.e.,. we must simulate. For example, historical simulation VaR, monte carlo
Classic example: Black-Scholes is closed form (we have a formula) versus binomial (we brute force a simulation in the open lattice)
Structural versus reduced form implies the credit risk models. See credit risk models de Servigny.
Merton model for PD is structural; i.e., based on balance sheet structure (assets, debt), by variable within (endogenous) to the company. And indeed, the merton is "analytic" or closed form, as above.
Reduced form does not explain PD with company-specific variables, no cause-and-effect to expain the default. Is in "actuarial" model; e.g., CreditRisk+
David
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