Modelling the Evolution of Credit Spreads Using the Cox Process Within the HJM Framework A CDS Option Pricing Model

Carl Chiarella, Viviana Fanelli and Silvana Musti
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Viviana Fanelli: Dipartimento di Scienze Economiche, Matematiche e Statistiche, Università degli Studi di Foggia
Silvana Musti: Dipartimento di Scienze Economiche, Matematiche e Statistiche, Università degli Studi di Foggia

No 255, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: In this paper a simulation approach for defaultable yield curves is developed within the Heath et al. (1992) framework. The default event is modelled using the Cox process where the stochastic intensity represents the credit spread. The forward credit spread volatility function is affected by the entire credit spread term structure. The paper provides the defaultable bond and credit default swap option price in a probability setting equipped with a sub filtration structure. The Euler-Maruyama stochastic integral approximation and the Monte Carlo method are applied to develop a numerical algorithm for pricing. Finally, the Antithetic Variable technique is used to reduce the variance of credit default swap option prices.

Keywords: pricing; HJM model; Cox process; Monte Carlo method; CDS option (search for similar items in EconPapers)
JEL-codes: C63 G13 G33 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2009-08-01
New Economics Papers: this item is included in nep-cmp and nep-ore
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Published as: Chiarella, C., Fanelli, V. and Musti, S., 2011, "Modelling the Evolution of Credit Spreads Using the Cox Process Within the HJM Framework A CDS Option Pricing Model", European Journal of Operational Research, 208(2), 95-108.

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https://www.uts.edu.au/sites/default/files/qfr-archive-03/QFR-rp255.pdf (application/pdf)

Related works:
Journal Article: Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model (2011)
Working Paper: Modelling the Evolution of Credit Spreads using the Cox Process within the HUM Framework: A CDS Option Pricing Model (2008)
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