Pricing basket default swaps in a tractable shot noise model

Alexander Herbertsson, Jiwook Jang and Thorsten Schmidt

Statistics & Probability Letters, 2011, vol. 81, issue 8, 1196-1207

Abstract: We value CDS spreads and kth-to-default swap spreads in a tractable shot noise model. The default dependence is modelled by letting the individual jumps of the default intensity be driven by a common latent factor. The arrival of the jumps is driven by a Poisson process. By using conditional independence and properties of the shot noise processes we derive tractable closed form expressions for the default distribution and the ordered survival distributions. These quantities are then used to price kth-to-default swap spreads. We calibrate a homogeneous version of the model to the term structure on market data from the iTraxx Europe index series sampled during the period 2008-01-14 to 2010-02-11. We perform 435 calibrations in this turbulent period and almost all calibrations yield very good fits. Finally we study kth-to-default spreads in the calibrated model.

Keywords: Credit; risk; Intensity-based; models; Dependence; modelling; Shot; noise; kth-to-default; swaps (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (5)

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