Counterparty Risk for Credit Default Swaps: Markov Chain Interacting Intensities Model With Stochastic Intensity

17 Pages Posted: 14 Jul 2009

See all articles by Kwai Sun Leung

Kwai Sun Leung

Hong Kong University of Science & Technology (HKUST)

Yue Kuen Kwok

Hong Kong University of Science & Technology - Department of Mathematics

Date Written: June 20, 2009

Abstract

We analyze the counterparty risk for credit default swaps using the Markov chain model of portfolio credit risk of multiple obligors with interacting default intensity processes. The default correlation between the protection seller and underlying entity is modeled by an increment in default intensity upon the occurrence of an external shock event. The arrival of the shock event is a Cox process whose stochastic intensity is assumed to follow an affine diffusion process with jumps. We examine how the correlated default risks between the protection seller and the underlying entity may affect the credit default premium in a credit default swap.

Keywords: credit default swaps, counterparty risk, Markov chain model

JEL Classification: G12, G13

Suggested Citation

Leung, Kwai Sun and Kwok, Yue Kuen, Counterparty Risk for Credit Default Swaps: Markov Chain Interacting Intensities Model With Stochastic Intensity (June 20, 2009). Available at SSRN: https://ssrn.com/abstract=1423262 or http://dx.doi.org/10.2139/ssrn.1423262

Kwai Sun Leung

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Yue Kuen Kwok (Contact Author)

Hong Kong University of Science & Technology - Department of Mathematics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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