A Spread-Based Model for the Valuation of Credit Derivatives with Correlated Defaults and Counter-Party Risks

Chuang Chang Chang, Yu Jih-Chieh

Research output: Chapter in Book/Report/Conference proceedingChapterpeer-review

Abstract

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 Kamrad and Ritchken (1991) 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.

Original languageEnglish
Title of host publicationResearch in Finance
EditorsAndrew Chen
Pages193-220
Number of pages28
DOIs
StatePublished - 2006

Publication series

NameResearch in Finance
Volume23
ISSN (Print)0196-3821

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