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Pricing And Hedging Of Portfolio Credit Derivatives With Interacting Default Intensities

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  • RÜDIGER FREY

    () (Department of Mathematics, University of Leipzig, 04009 Leipzig, Germany)

  • JOCHEN BACKHAUS

    () (Department of Mathematics, University of Leipzig, 04009 Leipzig, Germany)

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    Abstract

    We consider reduced-form models for portfolio credit risk with interacting default intensities. In this class of models default intensities are modeled as functions of time and of the default state of the entire portfolio, so that phenomena such as default contagion or counterparty risk can be modeled explicitly. In the present paper this class of models is analyzed by Markov process techniques. We study in detail the pricing and the hedging of portfolio-related credit derivatives such as basket default swaps and collaterized debt obligations (CDOs) and discuss the calibration to market data.

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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): 11 (2008)
    Issue (Month): 06 ()
    Pages: 611-634

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    Handle: RePEc:wsi:ijtafx:v:11:y:2008:i:06:p:611-634

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    Related research

    Keywords: Credit derivatives; CDOs; hedging; Markov chains;

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    Cited by:
    1. Didier Rullière & Diana Dorobantu & Areski Cousin, 2009. "An extension of Davis and Lo's contagion model," Working Papers hal-00374367, HAL.
    2. Sebastian Heise & and Reimer Kuehn, 2012. "Derivatives and Credit Contagion in Interconnected Networks," Papers 1202.3025, arXiv.org.
    3. Jean-David Fermanian & Olivier Vigneron, 2012. "On break-even correlation: the way to price structured credit derivatives by replication," Papers 1204.2251, arXiv.org.
    4. Emilio Barucci & Marco Tolotti, 2009. "The dynamics of social interaction with agents’ heterogeneity," Working Papers 189, Department of Applied Mathematics, Università Ca' Foscari Venezia.
    5. Takada, Hideyuki & Sumita, Ushio, 2011. "Credit risk model with contagious default dependencies affected by macro-economic condition," European Journal of Operational Research, Elsevier, vol. 214(2), pages 365-379, October.
    6. Frey, Rüdiger & Backhaus, Jochen, 2010. "Dynamic hedging of synthetic CDO tranches with spread risk and default contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 710-724, April.
    7. Areski Cousin & Stéphane Crépey & Yu Kan, 2012. "Delta-hedging correlation risk?," Review of Derivatives Research, Springer, vol. 15(1), pages 25-56, April.

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