Linear Credit Risk Models

51 Pages Posted: 21 May 2016 Last revised: 23 Jul 2019

See all articles by Damien Ackerer

Damien Ackerer

Swissquote Bank

Damir Filipović

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: July 6, 2019

Abstract

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

Ackerer, Damien and Filipovic, Damir, Linear Credit Risk Models (July 6, 2019). Finance and Stochastics, Forthcoming; Swiss Finance Institute Research Paper No. 16-34; Paris December 2016 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2782455 or http://dx.doi.org/10.2139/ssrn.2782455

Damien Ackerer

Swissquote Bank ( email )

Ch. de la Crétaux 33
Gland, Vaud 1196
Switzerland

Damir Filipovic (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Odyssea
Station 5
Lausanne, 1015
Switzerland

HOME PAGE: http://people.epfl.ch/damir.filipovic

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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