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Multi-Credit Calibration via Elastically Stopped L\'{e}vy Processes

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  • Graeme Baker
  • Agostino Capponi

Abstract

We calibrate credit default swaps and index tranches with elastically stopped L\'evy processes: each firm defaults when the running supremum of a latent, spectrally positive distress process crosses an independent exponential barrier. This yields a Cox construction with totally inaccessible default times, while retaining the interpretability and explicit formulas of a structural approach. Adding a single common compound Poisson jump factor to every firm's latent driver gives a parsimonious multi-credit model with simultaneous defaults, which is priced by an exact Wiener--Hopf Monte Carlo scheme. Its tractability rests on a single-name result we prove: a finite partial-fraction formula for the Laplace transform of the default probability under phase-type jumps. On daily CDX North American High-Yield and Investment-Grade panels, our drivers attain the lowest out-of-sample errors in a six-model field and reproduce the inverted spread curves of names heading into default, which a L\'evy subordinator provably does not. At the index level, the two-parameter dependence structure closes $73\%$ to $89\%$ of the tranche pricing gap left by independent marginals with the dependence parameters frozen, and up to $95\%$ once re-marked to tranche quotes; our framework dominates a single-factor Gaussian copula and the affine intensity benchmark of Duffie--G\^arleanu on both indices.

Suggested Citation

  • Graeme Baker & Agostino Capponi, 2026. "Multi-Credit Calibration via Elastically Stopped L\'{e}vy Processes," Papers 2608.10321, arXiv.org.
  • Handle: RePEc:arx:papers:2608.10321
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    File URL: https://arxiv.org/pdf/2608.10321
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