Abstract
Credit risk modeling is about modeling losses. These losses are typically coming unexpectedly and triggered by shocks. So any process modeling the stochastic nature of losses should reasonable include jumps. In this paper we review a few jump driven models for the valuation of Credit Default Swaps (CDSs) and show how under these dynamic models also pricing of (exotic) derivatives on single name CDSs is possible. More precisely, we set up fundamental firm-value models that allow for fast pricing of the ‘vanillas’ of the CDS derivative markets: payer and receiver swaptions. It turns out that the proposed model is able to produce realistic implied volatility smiles. Moreover, we detail how a CDS spread simulator can be set up under this framework and illustrate its use for the pricing of exotic derivatives with single name CDSs as underliers.
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Acknowledgements
H. Jönsson is an EU-Marie Curie Intra-European Fellow with funding from the European Community’s Sixth Framework Programme (MEIF-CT-2006-041115).
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Open Access This is an open access article distributed under the terms of the Creative Commons Attribution Noncommercial License (https://creativecommons.org/licenses/by-nc/2.0), which permits any noncommercial use, distribution, and reproduction in any medium, provided the original author(s) and source are credited.
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Jönsson, H., Schoutens, W. Single name credit default swaptions meet single sided jump models. Rev Deriv Res 11, 153–169 (2008). https://doi.org/10.1007/s11147-008-9027-9
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DOI: https://doi.org/10.1007/s11147-008-9027-9
Keywords
- Single sided Levy processes
- Structural models
- Credit risk
- Default probability
- Credit Default Swaptions
- Option pricing