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Levy Density Based Intensity Modeling of the Correlation Smile

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  • Balakrishna, B S

Abstract

The jump distribution for the default intensities in a reduced form framework is modeled and calibrated to provide reasonable fits to CDX.NA.IG and iTraxx Europe CDOs, to 5, 7 and 10 year maturities simultaneously. Calibration is carried out using an efficient Monte Carlo simulation algorithm suitable for both homogeneous and heterogeneous collections of credit names. The underlying jump process is found to relate closely to a maximally skewed stable Levy process with index of stability alpha ~ 1.5.

Suggested Citation

  • Balakrishna, B S, 2008. "Levy Density Based Intensity Modeling of the Correlation Smile," MPRA Paper 14922, University Library of Munich, Germany, revised 06 Apr 2009.
  • Handle: RePEc:pra:mprapa:14922
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    File URL: https://mpra.ub.uni-muenchen.de/14922/1/MPRA_paper_14922.pdf
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    References listed on IDEAS

    as
    1. Balakrishna, B S, 2007. "Delayed Default Dependency and Default Contagion," MPRA Paper 14921, University Library of Munich, Germany, revised 15 May 2007.
    2. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
    3. Lindskog, Filip & McNeil, Alexander J., 2003. "Common Poisson Shock Models: Applications to Insurance and Credit Risk Modelling," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 33(02), pages 209-238, November.
    4. Damiano Brigo & Andrea Pallavicini & Roberto Torresetti, 2008. "Default correlation, cluster dynamics and single names: The GPCL dynamical loss model," Papers 0812.4163, arXiv.org.
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    Cited by:

    1. Balakrishna, B S, 2010. "Levy Subordinator Model of Default Dependency," MPRA Paper 21386, University Library of Munich, Germany.
    2. Balakrishna, B S, 2010. "Levy Subordinator Model: A Two Parameter Model of Default Dependency," MPRA Paper 26274, University Library of Munich, Germany.

    More about this item

    Keywords

    Default Risk; Default Correlation; Default Intensity; Intensity Model; Levy Density; CDO; Monte Carlo;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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