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The Stochastic Intensity Ssrd Model Implied Volatility Patterns For Credit Default Swap Options And The Impact Of Correlation

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Author Info

  • DAMIANO BRIGO

    ()
    (Credit Models, Banca IMI, Corso Matteotti 6, 20121 Milano, Italy)

  • LAURENT COUSOT

    ()
    (Courant Institute, New York University, 251 Mercer Street, New York, NY 10012, USA)

Abstract

In this paper we investigate implied volatility patterns in the Shifted Square Root Diffusion (SSRD) model as functions of the model parameters. We begin by recalling the Credit Default Swap (CDS) options market model that is consistent with a market Black-like formula, thus introducing a notion of implied volatility for CDS options. We examine implied volatilities coming from SSRD prices and characterize the qualitative behavior of implied volatilities as functions of the SSRD model parameters. We introduce an analytical approximation for the SSRD implied volatility that follows the same patterns in the model parameters and that can be used to have a first rough estimate of the implied volatility following a calibration. We compute numerically the CDS-rate volatility smile for the adopted SSRD model. We find a decreasing pattern of SSRD implied volatilities in the interest-rate/intensity correlation. We check whether it is possible to assume zero correlation after the option maturity in computing the option price.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 09 (2006)
Issue (Month): 03 ()
Pages: 315-339

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Handle: RePEc:wsi:ijtafx:v:09:y:2006:i:03:p:315-339

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Keywords: Stochastic intensity model; credit default swap; calibration; option pricing; credit spread volatility; Monte Carlo simulation;

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