Herbertsson, Alexander () (Department of Economics, School of Business, Economics and Law, Göteborg University) Rootzén, Holger () (Department of Mathematical Statistic)
Abstract
We study a model for default contagion in intensity-based credit risk and its consequences for pricing portfolio credit derivatives. The model is specified through default intensities which are assumed to be constant between defaults, but which can jump at the times of defaults. The model is translated into a Markov jump process which represents the default status in the credit portfolio. This makes it possible to use matrix-analytic methods to derive computationally tractable closed-form expressions for single-name credit default swap spreads and kth-to-default swap spreads. We ”semicalibrate” the model for portfolios (of up to 15 obligors) against market CDS spreads and compute the corresponding kth-to-default spreads. In a numerical study based on a synthetic portfolio of 15 telecom bonds we study a number of questions: how spreads depend on the amount of default interaction; how the values of the underlying market CDS-prices used for calibration influence kth-th-to default spreads; how a portfolio with inhomogeneous recovery rates compares with a portfolio which satisfies the standard assumption of identical recovery rates; and, finally, how well kth-th-to default spreads in a nonsymmetric portfolio can be approximated by spreads in a symmetric portfolio.
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Publisher Info
Paper provided by Göteborg University, Department of Economics in its series Working Papers in Economics with number
269.
Length: 28 pages Date of creation: 31 Oct 2007 Date of revision: Handle: RePEc:hhs:gunwpe:0269
Contact details of provider: Postal: Department of Economics, School of Business, Economics and Law, Göteborg University Box 640, SE 405 30 GÖTEBORG, Sweden Phone: 031-773 10 00 Web page: http://www.handels.gu.se/econ/ More information through EDIRC
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