Sovereign CDS Calibration under a Hybrid Sovereign Risk Model

28 Pages Posted: 9 Dec 2018

See all articles by Gian Luca De Marchi

Gian Luca De Marchi

UnipolSai Assicurazioni SpA

Marco Di Francesco

UnipolSai Assicurazioni SpA

Sidy Diop

University of Bologna

Andrea Pascucci

University of Bologna - Department of Mathematics

Date Written: November 18, 2018

Abstract

The European sovereign debt crisis, started in the second half of 2011, has posed the problem for asset managers, trades and risk managers to assess sovereign default risk. In the reduced form framework, it is necessary to understand the interrelationship between creditworthiness of a sovereign, its intensity to default and the correlation with the exchange rate between the bond's currency and the currency in which the CDS spread are quoted. To do this, we propose a hybrid sovereign risk model in which the intensity of default is based on the jump to default extended CEV model. We analyze the differences between the default intensity under the domestic and foreign measure and we compute the default-survival probabilities in the bond's currency measure. We also give an approximation formula to CDS spread obtained by perturbation theory and provide an efficient method to calibrate the model to CDS spread quoted by the market. Finally, we test the model on real market data by several calibration experiments to confirm the robustness of our method.

Keywords: credit default swap; hybrid credit-equity model; Constant Elasticity of Variance model; asymptotic expansion; Foreign exchange rate

Suggested Citation

De Marchi, Gian Luca and Di Francesco, Marco and Diop, Sidy and Pascucci, Andrea, Sovereign CDS Calibration under a Hybrid Sovereign Risk Model (November 18, 2018). Applied Mathematical Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3286579

Gian Luca De Marchi

UnipolSai Assicurazioni SpA ( email )

Via Stalingrado 53
Bologna, 40128
Italy

Marco Di Francesco

UnipolSai Assicurazioni SpA ( email )

Via Stalingrado 53
Bologna, 40128
Italy

Sidy Diop (Contact Author)

University of Bologna ( email )

Piazza Scaravilli 2
Bologna, 40100
Italy

Andrea Pascucci

University of Bologna - Department of Mathematics ( email )

Piazzadi Porta San Donato, 5
Bologna, 40126
Italy

HOME PAGE: http://www.dm.unibo.it/~pascucci

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