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Counterparty Risk For Credit Default Swap With States Related Default Intensity Processes

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Author Info

  • DAN TANG

    ()
    (School of International Trade and Economics, University of International Business and Economics, Beijing, 100029, China)

  • YONGJIN WANG

    ()
    (School of Business and School of Mathematical Sciences, Nankai University, Tianjin, 300071, China)

  • YUZHEN ZHOU

    ()
    (Department of Statistics and Probability, Michigan State University, East Lansing MI, 48824, USA)

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    Abstract

    In this paper, the counterparty risk is considered in pricing a Credit Default Swap (abbr. CDS). We adopt an intensity-based reduced form model, in which the default intensity processes of the counterpart and the reference credit are modulated by the credit states of the firms. Two Markov chains are used to describe the credit state processes. We set up a model where the default correlation between the counterpart and the reference is described through the Markov chains. A semi-explicit formula for the pricing of CDS with counterparty risk is obtained. We analyze the impacts of default correlations and the state changes on the CDS price through some numerical experiments.

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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): 14 (2011)
    Issue (Month): 08 ()
    Pages: 1335-1353

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    Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:08:p:1335-1353

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    Related research

    Keywords: Credit default swap; counterparty risk; Markov modulated processes;

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