Pricing basket default swaps in a tractable shot-noise model

Alexander Herbertsson (), Jiwook Jang () and Thorsten Schmidt ()
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Alexander Herbertsson: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: Box 640, SE 40530 GÖTEBORG
Jiwook Jang: Department of Actuarial Studies, Faculty of Business and Economics, Macquarie University, Postal: NSW Australia 2109
Thorsten Schmidt: Department of Mathematics, University of Chemnitz, Postal: Reichen-, hainer Strasse 41,, 09126 Chemnitz, Germany

No 359, Working Papers in Economics from University of Gothenburg, Department of Economics

Abstract: We value CDS spreads and kth-to-default swap spreads in a tractable shot noise model. The default dependence is modelled by letting the individual jumps of the default intensity be driven by a common latent factor. The arrival of the jumps is driven by a Poisson process. By using conditional independence and properties of the shot noise processes we derive tractable closed-form expressions for the default distribution and the ordered survival distributions in a homogeneous portfolio. These quantities are then used to price and study CDS spreads and kth-to-default swap spreads as function of the model parameters. We study the kth-to-default spreads as function of the CDS spread, as well as other parameters in the model. All calibrations lead to perfect fits.

Keywords: Credit risk; intensity-based models; dependence modelling; shot noise; CDS; kth-to-default swaps (search for similar items in EconPapers)
JEL-codes: C02 C63 G13 G32 G33 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2009-04-27
New Economics Papers: this item is included in nep-fmk and nep-rmg
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