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Pricing inflation-indexed derivatives with default risk

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  • Son-Nan Chen
  • Pao-Peng Hsu

Abstract

Inflation-indexed derivatives with default risk are modeled using the jump-diffusion processes in the Heath–Jarrow–Morton’s (HJM) [(1992). “Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claim Valuation.” Econometrica 60: 77–105] framework. A four-factor HJM model is proposed by incorporating an exogenous intensity function into a foreign currency analogy under the three-factor HJM model proposed by Jarrow and Yildirim [(2003). “Pricing Treasury Inflation Protected Securities and Related Derivatives Using a HJM Model.” Journal of Financial and Quantitative Analysis 38: 337–358]. The proposed model improves the valuation accuracy of zero-coupon inflation-indexed swaps (IIS) through calibrating the model to swap market data. In addition, the valuation formulas of year-on-year IIS and caps with default risk are derived.

Suggested Citation

  • Son-Nan Chen & Pao-Peng Hsu, 2018. "Pricing inflation-indexed derivatives with default risk," The European Journal of Finance, Taylor & Francis Journals, vol. 24(15), pages 1272-1287, October.
    • Handle: RePEc:taf:eurjfi:v:24:y:2018:i:15:p:1272-1287
    DOI: 10.1080/1351847X.2017.1415217
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    Cited by:

    1. Hasan Dinçer & Serhat Yüksel & Fatih Pınarbaşı & Mehmet Ali Alhan, 2020. "Risky Financial Assets in Financial Integration and the Impacts of Derivatives on Banking Returns," World Scientific Book Chapters, in: Stéphane Goutte & Khaled Guesmi (ed.), Risk Factors and Contagion in Commodity Markets and Stocks Markets, chapter 6, pages 133-159, World Scientific Publishing Co. Pte. Ltd..

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