Fast Valuation of Forward-Starting Basket Default Swaps

International Journal of Theoretical and Applied Finance (IJTAF), 2010

Posted: 15 Jun 2010 Last revised: 21 Jun 2010

See all articles by Kenneth R. Jackson

Kenneth R. Jackson

University of Toronto - Department of Computer Science

Alexander Kreinin

affiliation not provided to SSRN

Wanhe Zhang

Department of Computer Science, University of Toronto

Date Written: March 1, 2010

Abstract

A basket default swap (BDS) is a credit derivative with contingent payments that are triggered by a combination of default events of the reference entities. A forward-starting basket default swap (FBDS) is a BDS starting at a specified future time. Existing analytic or semi-analytic methods for pricing FBDS are time consuming due to the large number of possible default combinations before the BDS starts. This paper develops a fast approximation method for FBDS based on the conditional independence framework. The method converts the pricing of a FBDS to an equivalent BDS pricing problem and combines Monte Carlo simulation with an analytic approach to achieve an effective method. This hybrid method is a novel technique which can be viewed either as a means to accelerate the convergence of Monte Carlo simulation or as a way to estimate parameters in an analytic method that are difficult to compute directly. Numerical results demonstrate the accuracy and efficiency of the proposed hybrid method.

Keywords: Credit derivatives, forward-starting basket default swaps, conditional independence, hybrid methods

Suggested Citation

Jackson, Kenneth R. and Kreinin, Alexander and Zhang, Wanhe, Fast Valuation of Forward-Starting Basket Default Swaps (March 1, 2010). International Journal of Theoretical and Applied Finance (IJTAF), 2010. Available at SSRN: https://ssrn.com/abstract=1621553

Kenneth R. Jackson (Contact Author)

University of Toronto - Department of Computer Science ( email )

Sandford Fleming Building
10 King's College Road, Room 3302
Toronto, Ontario M5S 3G4
Canada

Alexander Kreinin

affiliation not provided to SSRN ( email )

Wanhe Zhang

Department of Computer Science, University of Toronto ( email )

Sandford Fleming Building
10 King's College Road, Room 3302
Toronto, Ontario M5S 3G4
Canada

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