American Step-Up and Step-Down Default Swaps under Levy Models
AbstractThis paper studies the valuation of a class of default swaps with the embedded option to switch to a different premium and notional principal anytime prior to a credit event. These are early exercisable contracts that give the protection buyer or seller the right to step-up, step-down, or cancel the swap position. The pricing problem is formulated under a structural credit risk model based on Levy processes. This leads to the analytic and numerical studies of several optimal stopping problems subject to early termination due to default. In a general spectrally negative Levy model, we rigorously derive the optimal exercise strategy. This allows for instant computation of the credit spread under various specifications. Numerical examples are provided to examine the impacts of default risk and contractual features on the credit spread and exercise strategy.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1012.3234.
Date of creation: Dec 2010
Date of revision: Sep 2012
Publication status: Published in Quantitative Finance, 13(1): 137-157, 2013
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Web page: http://arxiv.org/
Other versions of this item:
- Tim Leung & Kazutoshi Yamazaki, 2013. "American step-up and step-down default swaps under Lévy models," Quantitative Finance, Taylor & Francis Journals, vol. 13(1), pages 137-157, January.
- NEP-ALL-2010-12-23 (All new papers)
- NEP-BAN-2010-12-23 (Banking)
- NEP-CMP-2010-12-23 (Computational Economics)
- NEP-RMG-2010-12-23 (Risk Management)
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.:
- Tim Leung & Ronnie Sircar, 2009. "Accounting For Risk Aversion, Vesting, Job Termination Risk And Multiple Exercises In Valuation Of Employee Stock Options," Mathematical Finance, Wiley Blackwell, vol. 19(1), pages 99-128.
- Egami, Masahiko & Leung, Tim & Yamazaki, Kazutoshi, 2013.
"Default swap games driven by spectrally negative Lévy processes,"
Stochastic Processes and their Applications,
Elsevier, vol. 123(2), pages 347-384.
- Masahiko Egami & Tim S. T. Leung & Kazutoshi Yamazaki, 2011. "Default Swap Games Driven by Spectrally Negative Levy Processes," Papers 1105.0238, arXiv.org, revised Sep 2012.
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