Credit Default Swap Calibration and Counterparty Risk Valuation with a Scenario based First Passage Model
AbstractIn this work we develop a tractable structural model with analytical default probabilities depending on a random default barrier and possibly random volatility ideally associated with a scenario based underlying firm debt. We show how to calibrate this model using a chosen number of reference Credit Default Swap (CDS) market quotes. In general this model can be seen as a possible extension of the time-varying AT1P model in Brigo and Tarenghi (2004). The calibration capability of the Scenario Volatility/Barrier model (SVBAT1P), when keeping time-constant volatility, appears inferior to the one of AT1P with time-varying deterministic volatility. The SVBAT1P model, however, maintains the benefits of time-homogeneity and can lead to satisfactory calibration results, as we show in a case study where we compare different choices on scenarios and parameters. Similarly to AT1P, SVBAT1P is suited to pricing hybrid equity/credit derivatives and to evaluate counterparty risk in equity payoffs, and more generally to evaluate hybrid credit/equity payoffs. We consider the equity return swap in Brigo and Tarenghi (2004) and show its valuation under SVBAT1P with the same CDS and equity calibration input used earlier for AT1P, and further we hint at equity default swap valuation in the conclusions.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 0912.3031.
Date of creation: Dec 2009
Date of revision:
Contact details of provider:
Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, Elsevier, vol. 24(1-2), pages 59-117, January.
- Merton, Robert C., 1973.
"On the pricing of corporate debt: the risk structure of interest rates,"
Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management
684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 29(2), pages 449-70, May.
- C. F. Lo & H. C. Lee & C. H. Hui, 2003. "A simple approach for pricing barrier options with time-dependent parameters," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 3(2), pages 98-107.
- Fisher, Lawrence, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, American Finance Association, vol. 39(3), pages 625-27, July.
- Damiano Brigo & Marco Tarenghi, 2009. "Credit Default Swap Calibration and Equity Swap Valuation under Counterparty Risk with a Tractable Structural Model," Papers 0912.3028, arXiv.org.
- Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, American Finance Association, vol. 39(3), pages 611-25, July.
- Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, American Finance Association, vol. 31(2), pages 351-67, May.
- Damiano Brigo, 2011. "Counterparty Risk FAQ: Credit VaR, PFE, CVA, DVA, Closeout, Netting, Collateral, Re-hypothecation, WWR, Basel, Funding, CCDS and Margin Lending," Papers 1111.1331, arXiv.org, revised Jun 2012.
- Damiano Brigo & Massimo Morini & Marco Tarenghi, 2009. "Credit Calibration with Structural Models: The Lehman case and Equity Swaps under Counterparty Risk," Papers 0912.4404, arXiv.org.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators).
If references are entirely missing, you can add them using this form.