An Explicit, Multi-Factor Credit Default Swap Pricing Model with Correlated Factors

Ren-Raw Chen, Xiaolin Cheng, Frank Fabozzi () and Bo Liu

Journal of Financial and Quantitative Analysis, 2008, vol. 43, issue 1, 123-160

Abstract: With the recent significant growth in the single-name credit default swap (CDS) market has come the need for accurate and computationally efficient models to value these instruments. While the model developed by Duffie, Pan, and Singleton (2000) can be used, the solution is numerical (solving a series of ordinary differential equations) rather than explicit. In this paper, we provide an explicit solution to the valuation of a credit default swap when the interest rate and the hazard rate are correlated by using the “change of measure” approach and solving a bivariate Riccati equation. CDS transaction data for the period 2/15/2000 through 4/8/2003 for 60 firms are used to test both the goodness of fit of the model and provide estimates of the influence of economic variables in the market for credit-risky bonds.

Date: 2008
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