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Fast Valuation Of Forward-Starting Basket Default Swaps

Author

Listed:
  • KEN JACKSON

    (Department of Computer Science, University of Toronto, 10 King's College Road, Toronto, ON, M5S 3G4, Canada)

  • ALEX KREININ

    (Algorithmics Inc., 185 Spadina Avenue, Toronto, ON, M5T 2C6, Canada)

  • WANHE ZHANG

    (Department of Computer Science, University of Toronto, 10 King's College Road, Toronto, ON, M5S 3G4, Canada)

Abstract

A basket default swap (BDS) is a credit derivative with contingent payments that are triggered by a combination of default events of the reference entities. A forward-starting basket default swap (FBDS) is a BDS starting at a specified future time. Existing analytic or semi-analytic methods for pricing FBDS are time consuming due to the large number of possible default combinations before the BDS starts. This paper develops a fast approximation method for FBDS based on the conditional independence framework. The method converts the pricing of a FBDS to an equivalent BDS pricing problem and combines Monte Carlo simulation with an analytic approach to achieve an effective method. This hybrid method is a novel technique which can be viewed either as a means to accelerate the convergence of Monte Carlo simulation or as a way to estimate parameters in an analytic method that are difficult to compute directly. Numerical results demonstrate the accuracy and efficiency of the proposed hybrid method.

Suggested Citation

  • Ken Jackson & Alex Kreinin & Wanhe Zhang, 2010. "Fast Valuation Of Forward-Starting Basket Default Swaps," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(02), pages 195-209.
    • Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:02:n:s0219024910005735
    DOI: 10.1142/S0219024910005735
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