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A spread-based model for the valuation of credit derivatives with correlated defaults and counter-party risks. (English) Zbl 1173.91403

Chen, Andrew H. (ed.), Research in finance. Amsterdam: Elsevier/JAI (ISBN 0-7623-1345-5/hbk). Research in Finance 23, 193-220 (2007).
Summary: We set out, in this paper, to extend the Das and Sundaram (2000) model as a means of simultaneously considering correlated default risk structure and counter-party risk. The multinomial model established by B. Kamrad and P. Ritchken [Manage. Sci. 37, No. 12, 1640–1652 (1991; Zbl 0825.90061)] is subsequently modified in order to facilitate the development of a computational algorithm for valuing two types of active credit derivatives, credit-spread options and default baskets. From our numerical examples, we find that along with the correlated default risk, the existence of counter-party risk results in a substantially lower valuation of credit derivatives. In addition, we find that different settings of the term structure of interest rate volatility also have a significant impact on the value of credit derivatives.
For the entire collection see [Zbl 1103.91034].

MSC:

91B30 Risk theory, insurance (MSC2010)
91B28 Finance etc. (MSC2000)

Citations:

Zbl 0825.90061
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