Successive Correlated Defaults in a Structural Model

We propose a multi-firm first-passage credit model in which investors have incomplete information. In this model, investors cannot observe a firm’s value process and its default barrier process. The model accounts for the short term risk inherent in default events, the market-wide impact of defaults on security prices due to counterparty relations between firms, and the cyclical default correlation effects observed in credit markets. We explicitly calculate the pricing trend and the arrival intensity of the first, second, etc. default. These results furnish (1) tractable reduced form formulas for arrival probabilities of successive correlated defaults and prices of multi-name credit derivatives that depend on the first, second etc. default, and (2) an algorithm for the simulation of successive unpredictable default times.