Interest rate swap pricing with default risk under variance gamma process

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Abstract

Under the assumption that the dynamic assets price follows the variance gamma process, we establish a new bilateral pricing model of interest rate swap by integrating the reduced form model for swap pricing and the structural model for default risk measurement. Our pricing model preserves the simplicity of the reduced form model and also considers the dynamic evolution of the counterparty assets price by incorporating with the structural model for default risk measurement. We divide the swap pricing framework into two parts, simplifying the pricing model relatively. Simulation results show that, for a one year interest rate swap, a bond spread of one hundred basis points implies a swap credit spread about 0.1054 basis point.

Keywords

variance gamma process interest rate swap default risk reduced form model structural model Monte Carlo Crank-Nicolson 

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Copyright information

© Editorial Committee of Applied Mathematics-A Journal of Chinese Universities and Springer-Verlag Berlin Heidelberg 2017

Authors and Affiliations

  1. 1.College of Economics and ManagementHangzhou Normal UniversityHangzhouChina
  2. 2.Zhejiang Yongan Technology Limited CorporationHangzhouChina

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