Inverting the Markovian projection for pure jump processes

Martin Larsson and Shukun Long

Papers from arXiv.org

Abstract: Markovian projections arise in problems where we aim to mimic the one-dimensional marginal laws of an It\^o semimartingale by using another It\^o process with simpler dynamics. In applications, Markovian projections are useful in calibrating jump-diffusion models with both local and stochastic features, leading to the study of the inversion problems. In this paper, we invert the Markovian projections for pure jump processes, which can be used to construct calibrated local stochastic intensity (LSI) models for credit risk applications. Such models are jump process analogues of the notoriously hard to construct local stochastic volatility (LSV) models used in equity modeling.

Date: 2024-12
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