Journal of Risk

Pricing to acceptability: with applications to valuation of one’s own credit risk

Ernst Eberlein, Thomas Gehrig and Dilip B. Madan


In this paper, the theory of pricing to acceptability developed for incomplete markets is applied to marking one's own default risk. Following the work of Heckman, it is observed that assets and liabilities are not to be valued identically in financial reporting. Liabilities are to be marked at the ask prices of two-price economies, which are above the asset mark at the bid prices for such economies. Applying cones of acceptability defined by concave distortions, it is observed that counterintuitive profitability resulting from credit deterioration is then mitigated. We argue that the difference between the liability mark at the two-price ask and the asset mark at the two-price bid should be taken as an upfront expense deposited in a special account called the own-default operating reserve account. Procedures are described separately for pricing coupon bonds as assets and liabilities. These procedures utilize the default time distribution embedded in the credit default swap market.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to View our subscription options

If you already have an account, please sign in here.

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: