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Calibrating risk-neutral default correlation

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  • Elisa Luciano

Abstract

The implementation of credit risk models has largely relied on the use of historical default dependence, as proxied by the correlation of equity returns. However, as is well known, credit derivative pricing requires risk-neutral dependence. Using the copula methodology, we infer risk neutral dependence from CDS data. We also provide a market application and explore its impact on the fees of some credit derivatives.

Suggested Citation

  • Elisa Luciano, 2005. "Calibrating risk-neutral default correlation," ICER Working Papers - Applied Mathematics Series 12-2005, ICER - International Centre for Economic Research.
    • Handle: RePEc:icr:wpmath:12-2005
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    File URL: http://www.bemservizi.unito.it/repec/icr/wp2005/ICERwp12-05.pdf
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    References listed on IDEAS

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    1. Roberto Blanco & Simon Brennan & Ian W Marsh, 2004. "An empirical analysis of the dynamic relationship between investment-grade bonds and credit default swaps," Bank of England working papers 211, Bank of England.
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    Cited by:

    1. Kwamie Dunbar & Albert J. Edwards, 2007. "Empirical Analysis of Credit Risk Regime Switching and Temporal Conditional Default Correlation in Credit Default Swap Valuation: The Market liquidity effect," Working papers 2007-10, University of Connecticut, Department of Economics.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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