An Implied Volatility Model Determined By Credit Default Swaps
In this paper we propose a diffusion model relating the stock price dynamics to the CDS spread dynamics of a company by assuming a linear relationship between instantaneous stock volatility and CDS spread. To value contingent claims under this model we apply a finite elements discretization to the associated pricing partial differential equation. A robust calibration strategy is presented and numerical examples are studied to validate the model assumptions. Besides option pricing, we discuss further applications which are e.g. the identification of market situations allowing volatility and capital structure arbitrage.
Volume (Year): 15 (2012)
Issue (Month): 07 ()
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