Title: Valuation of a Credit Default Swap: The Stable Non-Gaussian versus the Gaussian Approach
Abstract: This empirical paper investigates the effect of different distributional assumptions governing defaultable bond price uncertainty on the price of a credit default swap. We value a credit default swap using the two-factor Hull-White (1994) model for the term structure of default-free Spot interest rates and the credit spread process of a Baa-rated bond index and use the fractional recovery model of Duffie-Singleton (1999) and its multiple default extension as given in Schönbucher (1996,1998). The model is implemented using a tree algorithm outlined in Schönbucher (1999) where one factor is used for the spot interest rate and the other factor is for the credit spread or the intensity rate of a Cox process. This tree representation permits correlation between the spot rate and the credit spread dynamics of the Baa bond index, enabling us to provide a model that better fits the term structure of default-free and defaultable bond prices. We compare the values of a credit default swap obtained when the underlying risk factors are modeled with Gaussian and stable non-Gaussian distributions.
Publication Year: 2003
Publication Date: 2003-01-01
Language: en
Type: book-chapter
Indexed In: ['crossref']
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Cited By Count: 1
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