DEFINITION of 'Jarrow Turnbull Model'

The Jarrow Turnbull credit risk model is one of the first reduced-form models for pricing credit risk. Developed by Robert Jarrow and Stuart Turnbull, the model utilizes multi-factor and dynamic analysis of interest rates to calculate the probability of default. Reduced-form models are one of two approaches to credit risk modeling, the other being structural.

BREAKING DOWN 'Jarrow Turnbull Model'

Structural models like the Jarrow Turnbull model assume that the modeler — like a company's managers — has complete knowledge of its assets and liabilities, leading to a predictable default time. Reduced-form models assume that the modeler — like the market — has incomplete knowledge about the company's condition, leading to an inaccessible default time. Structural models, often called "Merton" models, after the Nobel Laureate academic Robert C. Merton, are single-period models which derive their probability of default from the random variations in the unobservable value of a firm's assets. Because structural models are rather sensitive to the many assumptions underlying their design, Jarrow concluded that for pricing and hedging, reduced-form models are the preferred methodology.

In reality, credit risk scoring is a highly advanced field, involving both complex math and high octane computing. Most banks and credit rating agencies will use a combination of structural and reduced-form models, as well as proprietary variants, to assess credit risk. Structural models offer the built-in advantage of offering a link between the credit quality of a firm and the firm’s economic and financial conditions established Merton’s model. The Jarrow Turnbull reduced-form models utilize some of the same information but account for certain market parameters, as well as knowledge of a firm’s financial condition at a point in time.

RELATED TERMS
  1. Merton Model

    The Merton model is an analysis tool used to evaluate the credit ...
  2. Black's Model

    Black's Model is a variation of the popular Black-Scholes options ...
  3. Lyon & Turnbull

    Lyon & Turnbull is an international fine arts and antiques auction ...
  4. Multistage Dividend Discount Model

    The multistage dividend discount model is an equity valuation ...
  5. Predictive Modeling

    Predictive modeling is the process of using known results to ...
  6. Advanced Internal Rating-Based ...

    An advanced internal rating-based (AIRB) approach to credit risk ...
Related Articles
  1. Investing

    Financial Models You Can Create With Excel

    The relatively modest amount of time it takes to build these models can pay for itself by leading you to better investment decisions.
  2. Personal Finance

    The Best Financial Modeling Courses for Investment Bankers

    Obtain information, both general and comparative, about the best available financial modeling courses for individuals pursuing a career in investment banking.
  3. Investing

    Digging Into The Dividend Discount Model

    The DDM is one of the most foundational of financial theories, but it's only as good as its assumptions.
  4. Investing

    How Credit Rating Risk Affects Corporate Bonds

    Credit migration risk is a vital part of the credit risk assessment, specifically with regard to corporate bonds which underlie numerous rating changes.
  5. Investing

    Tesla Model 3 Overseas Launch Delayed to Next Year

    Elon Musk took to Twitter to let the world know that international expansion is being delayed.
  6. Investing

    Musk Hands Over First Keys to Tesla Model 3 Owners

    The first set of Model 3 owners, who are Tesla employees, will receive the keys to their cars from CEO Elon Musk.
  7. Investing

    Style Matters In Financial Modeling

    If you're looking to get a job as an analyst, you'll need to know how to work it.
  8. Investing

    TD Ameritrade Adds CLS Investment Models to Model Market Center

    TD Ameritrade has expanded its Model Market Center to include models from CLS Investments.
  9. Trading

    How to Build Valuation Models Like Black-Scholes

    Want to build a model like Black-Scholes? Here are the tips and guidelines.
  10. Personal Finance

    Tesla Reveals First Mass Market Electric Vehicle (TSLA)

    Tesla yesterday unveiled the world's first mass-market electric vehicle. Will it succeed?
RELATED FAQS
  1. How do subscription business models work?

    Understand how a subscription business model works and why companies prefer a subscription business model over a traditional ... Read Answer >>
  2. Can a Best Buy credit card help you build credit?

    Learn about how using a Best Buy credit card responsibly can lead to a higher credit score and lower interest rates on mortgages ... Read Answer >>
Trading Center