The Jarrow–Turnbull model is a widely used "reduced-form" credit risk model. It was published in 1995 by Robert A. Jarrow and Stuart Turnbull.Robert A. Jarrow and Stuart Turnbull, "Pricing Derivatives on Financial Securities Subject to Credit Risk" Journal of Finance, vol. 50, March, 1995 Under the model, which returns the corporate's probability of default, bankruptcy is modeled as a statistical process. The model extends the reduced-form model of Merton (1976) Robert Merton, “Option Pricing When Underlying Stock Returns are Discontinuous” Journal of Financial Economics, 3, January–March, 1976, pp. 125–44. to a random interest rates framework.
Reduced-form models are an approach to credit risk modeling that contrasts sharply with "structural credit models", the best known of which is the Merton model of 1974. Reduced-form models focus on modeling the probability of default as a statistical process, whereas structural-models inhere a microeconomic model of the firm's capital structure, deriving the (single-period) probability of default from the random variation in the (unobservable) value of the firm's assets.Robert C. Merton “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,” Journal of Finance 29, 1974, pp. 449–470 Large financial institutions employ default models of both the structural and reduced-form types.
See also Credit default swap Credit derivatives Credit risk Merton model Probability of default
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