Credit risk modelling and integration of actuarial science and financial risk

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This research proposal presents interdisciplinary projects on the interface of actuarial science, credit risk, mathematics, and statistics. This proposal aims at three major goals:1. Credit risk modelling based on the forward default intensityDuffie and Lando (2001) and Giesecke (2005) show that the structural credit risk model usually does not define an intensity process when the firm value is continuously observable. Chen (2006) refers to this intensity as the instantaneous default intensity and shows that an alternative forward default intensity process does exist when some conditions are satisfied. This proposal intends to develop results on the forwad intensity using different kinds of firm values processes under the complete information system, the incomplete information system, and the asymmetric information system.2. New mathematical methods of the credit spread decompositionTraditional credit risk models usually treat the credit spread as a function of the probability of default and the mean recovery rate. Hull, Predescu, and White (2005) show that the risk premiums demanded by bonds traders include not only the probability of default and the mean recovery rate, but also liquidation risk, non-diversifiable risk, and contagion risk. Hull, Predescu, and White (2005) present this concept while this proposal intends to establish mathematical methods of the credit risk decomposition.  3. Integration of actuarial science and financial riskUnder the Financial Service Act (1999), insurance companies and banks, two originally distinct lines of business, can be combined and operated within one financial institution. Because the Basel II and the new Solvency II will be effective soon, the capital cushion to alleviate future losses, the actuarial liability and the financial minimal capital covering market risk, credit risk, and operational risk, should be evaluated together. Timely research integrating these risks is very important to financial institutions and the financial market.