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Pricing of CDS Options with the HJM approach: a Numerical Implementation

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  • Viviana Fanelli

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  • Silvana Musti

    ()

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    Abstract

    This paper provides CDS option pricing in a probability setting equipped with a subfiltration structure. The evolution of the defaultable term structure is modelled using the approach developed in Heath et al. (1992) when the spot rate and the forward rate affect the volatility term. The Euler-Maruyama stochastic integral approximation and the Monte Carlo method are applied to develop a numerical algorithm for pricing. Finally, the Antithetic Variables technique is used to reduce the variance of estimations.

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    Bibliographic Info

    Paper provided by Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia in its series Quaderni DSEMS with number 26-2007.

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    Length: 15 pages
    Date of creation: Dec 2007
    Date of revision:
    Handle: RePEc:ufg:qdsems:26-2007

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    Related research

    Keywords: HJM model; Cox process; Monte Carlo method; CDS option;

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    1. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
    2. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
    3. Chiarella, Carl & Clewlow, Les & Musti, Silvana, 2005. "A volatility decomposition control variate technique for Monte Carlo simulations of Heath Jarrow Morton models," European Journal of Operational Research, Elsevier, vol. 161(2), pages 325-336, March.
    4. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
    5. Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997. "A Markov Model for the Term Structure of Credit Risk Spreads," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 481-523.
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