AN IMPLIED VOLATILITY MODEL DETERMINED BY CREDIT DEFAULT SWAPS

Pascal Heider ()
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Pascal Heider: Mathematisches Institut der Universität zu Köln, Weyertal 86-90, 50931 Köln, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2012, vol. 15, issue 07, 1-21

Abstract: In this paper we propose a diffusion model relating the stock price dynamics to the CDS spread dynamics of a company by assuming a linear relationship between instantaneous stock volatility and CDS spread. To value contingent claims under this model we apply a finite elements discretization to the associated pricing partial differential equation. A robust calibration strategy is presented and numerical examples are studied to validate the model assumptions. Besides option pricing, we discuss further applications which are e.g. the identification of market situations allowing volatility and capital structure arbitrage.

Keywords: Implied volatility model; CDS spreads; stock options; finite elements; calibration (search for similar items in EconPapers)
Date: 2012
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DOI: 10.1142/S0219024912500495

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