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A tractable LIBOR model with default risk

Zorana Grbac and Antonis Papapantoleon

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Abstract: We develop a model for the dynamic evolution of default-free and defaultable interest rates in a LIBOR framework. Utilizing the class of affine processes, this model produces positive LIBOR rates and spreads, while the dynamics are analytically tractable under defaultable forward measures. This leads to explicit formulas for CDS spreads, while semi-analytical formulas are derived for other credit derivatives. Finally, we give an application to counterparty risk.

New Economics Papers: this item is included in nep-bec, nep-rmg and nep-upt
Date: 2012-02, Revised 2012-10
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Published in Mathematics and Financial Economics 2013, Vol 7, No 2, 203-227

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