Credit Derivative Pricing with Stochastic Volatility Models

Carl Chiarella, Samuel Chege Maina and Christina Nikitopoulos-Sklibosios ()

No 293, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper proposes a framework for pricing credit derivatives within the defaultable Markovian HJM framework featuring unspanned stochastic volatility. Motivated by empirical evidence, hump-shaped level dependent stochastic volatility specifications are proposed, such that the model admits finite dimensional Markovian structures. The model also accommodates a correlation structure between the stochastic volatility, default-free interest rates and credit spreads. Default free and defaultable bonds are explicitly priced and an approach for pricing credit default swaps and swaptions is presented where the credit swap rates can be approximated by defaultable bond prices with varying maturities. A sensitivity analysis capturing the impact of the model parameters including correlations and stochastic volatility, on the credit swap rate and the value of the credit swaption is also presented.

Keywords: stochastic volatility; Heath-Jarrow-Morton framework; defaultable bond prices; credit spreads; CDS rates (search for similar items in EconPapers)
Pages: 40 pages
Date: 2011-07-01
New Economics Papers: this item is included in nep-ban, nep-fmk and nep-ore
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Citations: View citations in EconPapers (1)

Published as: Chiarella, C., Mania, S. C. and Nikitopoulos-Sklibosios, C., 2013, "Credit Derivative Pricing with Stochastic Volatility Models", International Journal of Theoretical and Applied Finance, 16(4), 1-28.

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https://www.uts.edu.au/sites/default/files/qfr-archive-03/QFR-rp293.pdf (application/pdf)

Related works:
Journal Article: CREDIT DERIVATIVES PRICING WITH STOCHASTIC VOLATILITY MODELS (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:uts:rpaper:293

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