A Hidden Markov Reduced-form Risk Model

In this paper, we propose a reduced-form credit risk model with a hidden state process. The hidden state process is adopted to model the underlying economic environment with an observable state revealing the delayed and noisy information of the underlying economic state. Our model is a generalization of the work in Gu et al. [1]. Under this framework, we give a computational method to extract the underlying economic state and to find the distribution of multiple default times. Numerical experiment is conducted to illustrate the impact of change in observable state and the contagion effect of defaults.