I really want to participate in this event.
Below is what I read from an old article:
Although valuation models for defaultable securities date back to Merton (1974) and researchers have improved considerably on the basic Merton framework, problems remain. Table 1 highlights some of the advantages and disadvantages of using the valuation models discussed in this article. One class of models, sometimes referred to as structural models, requires the use of an imprecisely observed quantity (or quantities), such as a firm's value or variables related to it, in the valuation formula. In contrast, another class of models known as reduced-form models does not need firm-value-related variables and so holds more promise. It is often the case that the valuation formulas of reduced-form models are very similar to those used for valuing the corresponding default-free securities. The only difference is that the discounting factor is adjusted upward, taking into account the probability of default and the fraction of value lost upon default. Therefore, many of the existing results for valuing default-free securities such as default-free bonds can be readily extended to price default-risky securities. This advantage is significant as some of the models for valuing default-free securities are analytically and computationally tractable. Some of the reduced-form models can also incorporate the historical probabilities of credit-rating changes and defaults. These probabilities not only expand the information set used in valuation but also can be crucial for pricing instruments whose payoffs are explicitly linked to credit events, such as credit upgrades or downgrades.
However, because a limited amount of work has been done so far in validating the empirical efficacy of various reduced-form models, caution is warranted in using these models for pricing and hedging defaultable securities. Also, it is often the case that if one allows for realistic features, such as correlation between the interest rate level and default probabilities, historical probabilities of credit-rating changes and defaults can be used in a tractable fashion only under the questionable assumption that the risk premiums due to defaults and credit-rating changes are zero. Many of the institutional features of bankruptcy and defaults, such as renegotiation between the debtor and creditors and rescheduling of debts, cannot be readily incorporated in any of the valuation models discussed in this article as otherwise the models would be rendered intractable. It is hoped that the next generation of valuation models will be able to incorporate at least some institutional features and be able to use the historical probabilities of defaults and credit-rating changes without making unnecessarily strong assumptions.
