This paper presents a theoretical model of default risk in the context of the ``market'' model approach to interest rate dynamics. We propose a model for ®nite-interval interest rates (such as LIBOR) which explicitly takes into account the possibility of default through the in ̄uence of a point process with deterministic intensity. We relate the defaultable interest rate to the non-defaultable i...

The market for credit derivatives is growing rapidly. The credit derivative market’s global size was estimated to be $100 billion to $200 billion in 1996. The British Bankers Association estimated that the size was $1.6 trillion in 2001. Now the size is about $62 trillion [10]. The demand is strong because credit derivatives provide varieties that can fit different clients. The fundamental cred...

We model dynamic credit portfolio dependence by using default contagion in an intensity-based framework. Two different portfolios (with 10 obligors), one in the European auto sector, the other in the European financial sector, are calibrated against their market CDS spreads and the corresponding CDS-correlations. After the calibration, which are perfect for the banking portfolio, and good for t...

This review of the pricing of credit swaps, a form of derivative security that can be viewed as default insurance on loans or bonds, begins with a description of the credit swap contract, turns to pricing by reference to spreads over the risk-free rate of par floating-rate bonds of the same quality, and then considers model-based pricing. The role of asset swap spreads as a reference for pricin...

It is a well known fact that local scale invariance plays a fundamental role in the theory of derivative pricing. Specific applications of this principle have been used quite often under the name of ‘change of numeraire’, but in recent work it was shown that when invoked as a fundamental first principle, it provides a powerful alternative method for the derivation of prices and hedges of deriva...

Credit risk is quantified by the loss distribution due to unexpected changes in the credit quality of the counterparty in a financial contract. Default correlation risk refers to the risk that a bundle of risky obligors may default together. To understand the clustering phenomena in correlated defaults, we consider credit contagion models which describe the propagation of financial distress fro...

In their paper “Credit Default Swaps from the Viewpoint of Libertarian Property Rights and Contract Theory,” Thorsten Polleit and Jonathan Mariano attempt to show that credit default swaps (CDS) are legitimate and enforceable contracts under Murray Rothbard’s conception of property rights and contract theories. They also try to demonstrate that “CDS are an efficient and effective instrument for...

In this paper, we review recent advances in pricing tranches of a collateralized debt obligations and credit default swap indexes: one factor Gaussian copula model and its extensions, the structural model, and the loss process model. Then, we propose using heavy-tailed functions in future research. As background, we provide a brief explanation of collateralized debt obligations, credit default ...

Abstract In this paper we propose to study the dynamics of financial contagion between credit default swap (CDS) and sovereign bond markets through effective transfer entropy, a model-free methodology which enables overcome required hypotheses classical price discovery measures in statistical econometric literature, without being restricted linear dynamics. By means entropy correct for small sa...