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Enhancing credit default swap valuation with meshfree methods

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  • Guarin, Alexander
  • Liu, Xiaoquan
  • Ng, Wing Lon

Abstract

In this paper, we apply the meshfree radial basis function (RBF) interpolation to numerically approximate zero-coupon bond prices and survival probabilities in order to price credit default swap (CDS) contracts. We assume that the interest rate follows a Cox-Ingersoll-Ross process while the default intensity is described by the Exponential-Vasicek model. Several numerical experiments are conducted to evaluate the approximations by the RBF interpolation for one- and two-factor models. The results are compared with those estimated by the finite difference method (FDM). We find that the RBF interpolation achieves more accurate and computationally efficient results than the FDM. Our results also suggest that the correlation between factors does not have a significant impact on CDS spreads.

Suggested Citation

  • 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.
  • Handle: RePEc:eee:ejores:v:214:y:2011:i:3:p:805-813
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    Cited by:

    1. Mathieu Mercadier & Jean-Pierre Lardy, 2019. "Credit spread approximation and improvement using random forest regression," Post-Print hal-03241566, HAL.
    2. Mathieu Mercadier & Jean-Pierre Lardy, 2021. "Credit spread approximation and improvement using random forest regression," Papers 2106.07358, arXiv.org.
    3. 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.
    4. Alessandro Andreoli & Luca Vincenzo Ballestra & Graziella Pacelli, 2018. "Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach," Computational Economics, Springer;Society for Computational Economics, vol. 51(3), pages 379-406, March.
    5. Mitra, Sovan & Date, Paresh & Mamon, Rogemar & Wang, I-Chieh, 2013. "Pricing and risk management of interest rate swaps," European Journal of Operational Research, Elsevier, vol. 228(1), pages 102-111.
    6. Weiwei Liu & Zhile Yang & Kexin Bi, 2017. "Forecasting the Acquisition of University Spin-Outs: An RBF Neural Network Approach," Complexity, Hindawi, vol. 2017, pages 1-8, October.
    7. Mercadier, Mathieu & Lardy, Jean-Pierre, 2019. "Credit spread approximation and improvement using random forest regression," European Journal of Operational Research, Elsevier, vol. 277(1), pages 351-365.
    8. Li, Shuling & Li, Xiaolin, 2016. "Radial basis functions and level set method for image segmentation using partial differential equation," Applied Mathematics and Computation, Elsevier, vol. 286(C), pages 29-40.

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