IDEAS home Printed from https://ideas.repec.org/a/cup/jfinqa/v43y2008i01p123-160_00.html
   My bibliography  Save this article

An Explicit, Multi-Factor Credit Default Swap Pricing Model with Correlated Factors

Author

Listed:
  • Chen, Ren-Raw
  • Cheng, Xiaolin
  • Fabozzi, Frank J.
  • Liu, Bo

Abstract

With the recent significant growth in the single-name credit default swap (CDS) market has come the need for accurate and computationally efficient models to value these instruments. While the model developed by Duffie, Pan, and Singleton (2000) can be used, the solution is numerical (solving a series of ordinary differential equations) rather than explicit. In this paper, we provide an explicit solution to the valuation of a credit default swap when the interest rate and the hazard rate are correlated by using the “change of measure” approach and solving a bivariate Riccati equation. CDS transaction data for the period 2/15/2000 through 4/8/2003 for 60 firms are used to test both the goodness of fit of the model and provide estimates of the influence of economic variables in the market for credit-risky bonds.

Suggested Citation

  • Chen, Ren-Raw & Cheng, Xiaolin & Fabozzi, Frank J. & Liu, Bo, 2008. "An Explicit, Multi-Factor Credit Default Swap Pricing Model with Correlated Factors," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(01), pages 123-160, March.
  • Handle: RePEc:cup:jfinqa:v:43:y:2008:i:01:p:123-160_00
    as

    Download full text from publisher

    File URL: http://journals.cambridge.org/abstract_S0022109000002775
    File Function: link to article abstract page
    Download Restriction: no

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Peter Christoffersen & Christian Dorion & Kris Jacobs & Lotfi Karoui, 2014. "Nonlinear Kalman Filtering in Affine Term Structure Models," Management Science, INFORMS, vol. 60(9), pages 2248-2268, September.
    2. Marco Realdon, 2007. "A Two Factor Black-Karasinski Credit Default Swap Pricing Model (forthcoming in the Icfai Journal of Derivatives Markets, Vol IV, No 4, October 2007; all copyrights rest with the Icfai University Pres," Discussion Papers 07/25, Department of Economics, University of York.
    3. Nicole Thorne Jenkins & Michael D. Kimbrough & Juan Wang, 2016. "The extent of informational efficiency in the credit default swap market: evidence from post-earnings announcement returns," Review of Quantitative Finance and Accounting, Springer, vol. 46(4), pages 725-761, May.
    4. Bedendo, Mascia & Campolongo, Francesca & Joossens, Elisabeth & Saita, Francesco, 2010. "Pricing multiasset equity options: How relevant is the dependence function?," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 788-801, April.
    5. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.
    6. Guarin, Alexander & Liu, Xiaoquan & Ng, Wing Lon, 2011. "Enhancing credit default swap valuation with meshfree methods," European Journal of Operational Research, Elsevier, vol. 214(3), pages 805-813, November.
    7. Yalin Gündüz & Marliese Uhrig-Homburg, 2014. "Does modeling framework matter? A comparative study of structural and reduced-form models," Review of Derivatives Research, Springer, vol. 17(1), pages 39-78, April.
    8. Samson Assefa, 2007. "Calibration and Pricing in a Multi-Factor Quadratic Gaussian Model," Research Paper Series 197, Quantitative Finance Research Centre, University of Technology, Sydney.
    9. Monfort, Alain & Renne, Jean-Paul & Roussellet, Guillaume, 2015. "A Quadratic Kalman Filter," Journal of Econometrics, Elsevier, vol. 187(1), pages 43-56.
    10. Michael R King, 2009. "Time to buy or just buying time? The market reaction to bank rescue packages," BIS Working Papers 288, Bank for International Settlements.
    11. Chiarella, Carl & Fanelli, Viviana & Musti, Silvana, 2011. "Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model," European Journal of Operational Research, Elsevier, vol. 208(2), pages 95-108, January.
    12. Enrico Laghi & Michele Di Marcantonio & Eugenio D'Amico, 2014. "Estimating credit default swap spreads using accounting data, market quotes and credit ratings: the European Banks Case," FINANCIAL REPORTING, FrancoAngeli Editore, vol. 2014(2-3-4), pages 59-81.
    13. Guarin, Alexander & Liu, Xiaoquan & Ng, Wing Lon, 2014. "Recovering default risk from CDS spreads with a nonlinear filter," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 87-104.
    14. Madan, Dilip B., 2014. "Modeling and monitoring risk acceptability in markets: The case of the credit default swap market," Journal of Banking & Finance, Elsevier, vol. 47(C), pages 63-73.
    15. Samson Assefa, 2007. "Pricing of Defaultable Securities in a Multi-Factor Quadratic Gaussian Model," Research Paper Series 202, Quantitative Finance Research Centre, University of Technology, Sydney.
    16. Chen, Ren-Raw & Cheng, Xiaolin & Liu, Bo, 2008. "Estimation and evaluation of the term structure of credit default swaps: An empirical study," Insurance: Mathematics and Economics, Elsevier, vol. 43(3), pages 339-349, December.
    17. Tse, Yiuman & Wald, John K., 2013. "Insured uncovered interest parity," Finance Research Letters, Elsevier, vol. 10(4), pages 175-183.
    18. Michele Bianchi & Frank Fabozzi, 2015. "Investigating the Performance of Non-Gaussian Stochastic Intensity Models in the Calibration of Credit Default Swap Spreads," Computational Economics, Springer;Society for Computational Economics, vol. 46(2), pages 243-273, August.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cup:jfinqa:v:43:y:2008:i:01:p:123-160_00. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Keith Waters). General contact details of provider: http://journals.cambridge.org/jid_JFQ .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.