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Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach

Alessandro Andreoli (), Luca Vincenzo Ballestra () and Graziella Pacelli ()
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Alessandro Andreoli: Università Politecnica delle Marche
Luca Vincenzo Ballestra: Seconda Università di Napoli
Graziella Pacelli: Università Politecnica delle Marche

Computational Economics, 2018, vol. 51, issue 3, 379-406

Abstract: Abstract We present a new numerical method for pricing credit default swaps under fully correlated multifactor reduced-form models. In particular, the proposed approach combines an implicit/explicit operator splitting procedure with the harmonic differential quadrature scheme, and is so efficient that it can be applied to models with up to six stochastic factors. This is a remarkable advantage, as we can use two factors to describe the interest rate, other two factors to describe the default probability, and other two factors to take into account, for example, the so-called counterparty risk. The performances of the novel method are demonstrated by extensive simulation, in which various kinds of models with four and six fully correlated factors are considered.

Keywords: Credit default swap; CDS; Multifactor model; Operator splitting; Differential quadrature (search for similar items in EconPapers)
JEL-codes: C02 C63 G13 (search for similar items in EconPapers)
Date: 2018
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