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Fast Valuation Of Forward-Starting Basket Default Swaps

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Author Info

  • KEN JACKSON

    ()
    (Department of Computer Science, University of Toronto, 10 King's College Road, Toronto, ON, M5S 3G4, Canada)

  • ALEX KREININ

    ()
    (Algorithmics Inc., 185 Spadina Avenue, Toronto, ON, M5T 2C6, Canada)

  • WANHE ZHANG

    ()
    (Department of Computer Science, University of Toronto, 10 King's College Road, Toronto, ON, M5S 3G4, Canada)

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    Abstract

    A basket default swap (BDS) is a credit derivative with contingent payments that are triggered by a combination of default events of the reference entities. A forward-starting basket default swap (FBDS) is a BDS starting at a specified future time. Existing analytic or semi-analytic methods for pricing FBDS are time consuming due to the large number of possible default combinations before the BDS starts. This paper develops a fast approximation method for FBDS based on the conditional independence framework. The method converts the pricing of a FBDS to an equivalent BDS pricing problem and combines Monte Carlo simulation with an analytic approach to achieve an effective method. This hybrid method is a novel technique which can be viewed either as a means to accelerate the convergence of Monte Carlo simulation or as a way to estimate parameters in an analytic method that are difficult to compute directly. Numerical results demonstrate the accuracy and efficiency of the proposed hybrid method.

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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): 13 (2010)
    Issue (Month): 02 ()
    Pages: 195-209

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    Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:02:p:195-209

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    Related research

    Keywords: Credit derivatives; forward-starting basket default swaps; conditional independence; hybrid methods;

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