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A factor contagion model for portfolio credit derivatives

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  • Geon Ho Choe
  • Hyun Jin Jang
  • Soon Won Kwon

Abstract

We propose a factor contagion model with the Marshall-Olkin copula for correlated default times and develop an analytic approach for finding the th default time distribution based on our model. We combine a factor copula model with a contagion model under the assumption that the individual default intensities follow contagion processes, and that the default times have a dependence structure with the Marshall-Olkin copula. Then, we derive an analytic formula for the th default time distribution and apply it to compute the price of portfolio credit derivatives, such as th-to-default swaps and single-tranche CDOs. To test efficiency and accuracy of our formula, we compare the theoretical prediction with existing methods.

Suggested Citation

  • Geon Ho Choe & Hyun Jin Jang & Soon Won Kwon, 2015. "A factor contagion model for portfolio credit derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 15(9), pages 1571-1582, September.
    • Handle: RePEc:taf:quantf:v:15:y:2015:i:9:p:1571-1582
    DOI: 10.1080/14697688.2014.976651
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    References listed on IDEAS

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    1. Choe, Geon Ho & Jang, Hyun Jin, 2011. "Efficient algorithms for basket default swap pricing with multivariate Archimedean copulas," Insurance: Mathematics and Economics, Elsevier, vol. 48(2), pages 205-213, March.
    2. P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, September.
    3. Harry Zheng & Lishang Jiang, 2009. "Basket CDS pricing with interacting intensities," Finance and Stochastics, Springer, vol. 13(3), pages 445-469, September.
    4. Robert A. Jarrow & Fan Yu, 2008. "Counterparty Risk and the Pricing of Defaultable Securities," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515, World Scientific Publishing Co. Pte. Ltd..
    5. Harry Zheng, 2013. "Contagion models a la carte: which one to choose?," Quantitative Finance, Taylor & Francis Journals, vol. 13(3), pages 399-405, February.
    6. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
    7. Jia-Wen Gu & Wai-Ki Ching & Tak-Kuen Siu & Harry Zheng, 2013. "On pricing basket credit default swaps," Quantitative Finance, Taylor & Francis Journals, vol. 13(12), pages 1845-1854, December.
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    Cited by:

    1. Cerqueti, Roy & Giacalone, Massimiliano & Panarello, Demetrio, 2019. "A Generalized Error Distribution Copula-based method for portfolios risk assessment," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 524(C), pages 687-695.

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