A SPREAD-RETURN MEAN-REVERTING MODEL FOR CREDIT SPREAD DYNAMICS

Brendan O'Donoghue (), Matthew Peacock (), Jacky Lee () and Luca Capriotti ()
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Brendan O'Donoghue: Electrical Engineering Department, Stanford University, USA
Matthew Peacock: White Oak Asset Management SA, Switzerland
Jacky Lee: Quantitative Strategies, Investment Banking Division, Credit Suisse Group, United Kingdom
Luca Capriotti: Quantitative Strategies, Investment Banking Division, Credit Suisse Group, United Kingdom

International Journal of Theoretical and Applied Finance (IJTAF), 2014, vol. 17, issue 03, 1-14

Abstract: In this paper, we propose a novel, analytically tractable, one-factor stochastic model for the dynamics of credit default swap (CDS) spreads and their returns, which we refer to as the spread-return mean-reverting (SRMR) model. The SRMR model can be seen as a hybrid of the Black–Karasinski model on spreads and the Ornstein–Uhlenbeck model on spread returns, and is able to capture empirically observed properties of CDS spreads and returns, including spread mean-reversion, heavy tails of the return distribution, and return autocorrelations. Although developed for modeling CDS spreads, the SRMR model has applications for many other stochastic processes with similar empirical properties, including more general rate processes.

Keywords: Credit default swaps; credit risk; risk management; return autocorrelation; heavy tails; model fitting (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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DOI: 10.1142/S0219024914500174

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