Linear Credit Risk Models
Finance and Stochastics, Forthcoming
51 Pages Posted: 21 May 2016 Last revised: 23 Jul 2019
Date Written: July 6, 2019
We introduce a novel class of credit risk models in which the drift of the survival process of a firm is a linear function of the factors. The prices of defaultable bonds and credit default swaps (CDS) are linear-rational in the factors. The price of a CDS option can be uniformly approximated by polynomials in the factors. Multi-name models can produce simultaneous defaults, generate positively as well as negatively correlated default intensities, and accommodate stochastic interest rates. A calibration study illustrates the versatility of these models by fitting CDS spread time series. A numerical analysis validates the efficiency of the option price approximation method.
Keywords: credit default swap, credit derivatives, credit risk, polynomial model, survival process
JEL Classification: C51, G12, G13
Suggested Citation: Suggested Citation