Pricing default risk in stochastic time

This study examines the pricing of credit derivatives using the structural modeling framework. These types of models are known to have problems with accurately valuing derivative securities. To address these problems, this study proposes incorporating additional sources of risk associated with balance sheet dynamics. Specifically, the study introduces the hypothesis of imperfect balance sheet information (as previously explored by Duffie and Lando), which produces a realistic channel for the short-horizon default risk. Moreover, a stochastic time allowing for jumps is incorporated to capture the increased uncertainty over longer horizons, which could be linked to upcoming news or legal issues. Overall, the study demonstrates how these modifications can enhance the predictive power of structural models and improve their usefulness in real-world applications.