Default risk in interest rate derivatives with stochastic volatility

Bomi Kim and Jeong-Hoon Kim

Quantitative Finance, 2011, vol. 11, issue 12, 1837-1845

Abstract: In this study, we consider short interest rate models of the Vascicek type with stochastic volatility and obtain formulas for default risk in interest rate derivatives. Corrections from a fast mean-reverting stochastic volatility are computed to show how they can affect the term structure of the interest rate derivatives. Our results for the defaultable bonds as well as the corresponding bond options are obtained as an extension of the non-defaultable case studied by Cotton et al. [Math. Finance, 2004, 14(2), 173–200].

Date: 2011
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DOI: 10.1080/14697688.2010.543426

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