The Pricing of Total Return Swap Under Default Contagion Models with Jump-Diffusion Interest Rate Risk

Anjiao Wang ()
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Anjiao Wang: Shanghai University of International Business and Economics

Indian Journal of Pure and Applied Mathematics, 2020, vol. 51, issue 1, 361-373

Abstract: Abstract In this paper, we consider a two-firm default contagion model with counterparty risk and jumpdiffusion interest rate risk. Under this model, we study the pricing of total return swap(TRS). We assume that the interest rate follows the Vasicek jump-diffusion model, and obtain the Libor market interest rate. The case that default is related to the interest rate is considered. Using the method of change of measure and the properties of conditional expectations, the joint conditional survival probability and joint conditional density function are derived. Applying the arbitragefree pricing principle of TRS in the complete market, we price the swap rate of TRS and obtain the closed-form solution. And we analyze the effect of various factors on the price of TRS.

Keywords: Credit risk; default contagion; interest rate risk; jump-diffusion risk; Total return swap; 60A10; 60K35; 60J60; 60J75; 91B25 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1007/s13226-020-0405-9

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