Pricing credit default swaps under a multi-scale stochastic volatility model

Wenting Chen and Xinjiang He

Physica A: Statistical Mechanics and its Applications, 2017, vol. 468, issue C, 425-433

Abstract: In this paper, we consider the pricing of credit default swaps (CDSs) with the reference asset driven by a geometric Brownian motion with a multi-scale stochastic volatility (SV), which is a two-factor volatility process with one factor controlling the fast time scale and the other representing the slow time scale. A key feature of the current methodology is to establish an equivalence relationship between the CDS and the down-and-out binary option through the discussion of “no default” probability, while balancing the two SV processes with the perturbation method. An approximate but closed-form pricing formula for the CDS contract is finally obtained, whose accuracy is in the order of O(ϵ+δ+ϵδ).

Keywords: Credit default swaps; Multi-scale; Stochastic volatility; Perturbation method; Down-and-out binary option (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:468:y:2017:i:c:p:425-433

DOI: 10.1016/j.physa.2016.10.082

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