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Default dependence structure effects on the valuation of government guarantees

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  • Carlo Domenico Mottura
  • Luca Passalacqua

Abstract

The paper analyses the problem of evaluating a guarantee contract against default risk in which the guarantor party is defaultable and the default risks of the guarantor and of the borrower are correlated. This problem has several relevant applications within the present sovereign risk crisis. We have investigated the effects of the dependence structure between defaults events within a framework defined by the classical no-arbitrage market approach, considering intensity models driven by Cox processes for the term structure of survival prob- abilities and copula models to derive the joint distribution of default times. We compare numerical results on the probability of the guarantee being paid, for different values of the default intensities, using the Gaussian and the Marshall-Olkin copulas, finding relevant differencies and counter-intuitive dependence on the correlation parameter

Suggested Citation

  • Carlo Domenico Mottura & Luca Passalacqua, 2013. "Default dependence structure effects on the valuation of government guarantees," Departmental Working Papers of Economics - University 'Roma Tre' 0177, Department of Economics - University Roma Tre.
    • Handle: RePEc:rtr:wpaper:0177
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    File URL: http://dipeco.uniroma3.it/public/WP%20177.pdf
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    References listed on IDEAS

    as
    1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    2. Rodrigo Olivares-Caminal, 2012. "The EU Architecture to Avert a Sovereign Debt Crisis," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2011(2), pages 167-197.
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    More about this item

    Keywords

    government guarantees; default risk; correlation; Marshall-Olkin;
    All these keywords.

    JEL classification:

    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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