Credit Derivative Pricing with Stochastic Volatility Models
This paper proposes a framework for pricing credit derivatives within the defaultable Markovian HJM framework featuring unspanned stochastic volatility. Motivated by empirical evidence, hump-shaped level dependent stochastic volatility specifications are proposed, such that the model admits finite dimensional Markovian structures. The model also accommodates a correlation structure between the stochastic volatility, default-free interest rates and credit spreads. Default free and defaultable bonds are explicitly priced and an approach for pricing credit default swaps and swaptions is presented where the credit swap rates can be approximated by defaultable bond prices with varying maturities. A sensitivity analysis capturing the impact of the model parameters including correlations and stochastic volatility, on the credit swap rate and the value of the credit swaption is also presented.
|Date of creation:||01 Jul 2011|
|Publication status:||Published as: Chiarella, C., Mania, S. C. and Nikitopoulos-Sklibosios, C., 2013, "Credit Derivative Pricing with Stochastic Volatility Models", International Journal of Theoretical and Applied Finance, 16(4), 1-28.|
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- Carl Chiarella & Christina Nikitopoulos Sklibosios & Erik Schlögl, 2007. "A Markovian Defaultable Term Structure Model With State Dependent Volatilities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(01), pages 155-202.
- Carl Chiarella & Erik Schlögl & Christina Nikitopoulos-Sklibosios, 2004. "A Markovian Defaultable Term Structure Model with State Dependent Volatilities," Research Paper Series 135, Quantitative Finance Research Centre, University of Technology, Sydney.
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