What is the Jarrow Turnbull Model?

The Jarrow Turnbull Model was created by Robert Jarrow and Stuart Turnbull as a credit risk model that incorporates the tendency of default with interest rates in credits. This credit risk model estimates the probability of defaults on credits using the analysis of interest rates. The Jarrow Turnbull Model is a reduced-form model for pricing risks in credits.

How is the Jarrow Turnbull Model Used?

Generally, reduced-form models for pricing credit risk are based on the believe that modelers (managers of companies, the market and others) have a knowing of all market or company's structure making default times predictability easier. The Jarrow Turnbull model stems from the assumption that a modeler is fully aware of its liabilities and assets and can therefore predict default. The Jarrow Turnbull model is an extension of the 1976 Merton model. Estimating credit risk or Calculating the probability of default in a credit is not something that inexperienced people can handle, it is a tedious task best handled by experts and analysts. Credit risk modeling has two approaches, these are the reduced-form models and the structural models. Due to the inability of the structural models to capture many assumptions in the credit risk, the reduced-form models have become the preferred approach. One of the early reduced-form models for credit risk modelling is the Jarrow Turnbull model, it is based on using the knowledge about the interest rates of a credit to calculate default tendency.