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A Markov Modulated Dynamic Contagion Process with Application to Credit Risk

  • Puneet Pasricha
  • Dharmaraja SelvamuthuEmail author
Article
  • 32 Downloads

Abstract

Self-exciting point processes are applied to various fields such as seismology, finance, neurophysiology, criminology, biology etc to model the clustering/contagion phenomenon and extreme risk events. This article proposes an analytically tractable point process, a generalization of the classical Hawkes process, with the intensity process following a Markov modulated mean-reverting affine jump-diffusion process with contagion effects. The proposed process has both self-exciting and externally-exciting jumps that represent the effects of endogenous and exogenous events. This article derives the closed-form expressions, for distributional properties such as the first order moment, probability generating function (PGF) of the point process and Laplace transform of the intensity process, which makes it computationally efficient. The application of the proposed process to price the synthetic collateralized debt obligations (CDOs) in a top-down framework is also presented.

Keywords

Contagion process Affine jump diffusion process Credit risk Regime-switching 

Notes

Acknowledgements

Authors are thankful to the editor and two anonymous reviewers for their valuable suggestions and comments which helped improve the paper to great extent. The Puneet Pasricha is thankful to Council of Scientific and Industrial Research (CSIR) India for the financial grant.

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Department of MathematicsIndian Institute of Technology DelhiHauz KhasIndia

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