Credit Default Swap Calibration and Equity Swap Valuation Under Counterparty Risk with a Tractable Structural Model

36 Pages Posted: 25 Aug 2004

See all articles by Damiano Brigo

Damiano Brigo

Imperial College London - Department of Mathematics

Marco Tarenghi

Mediobanca

Date Written: August 24, 2004

Abstract

In this paper we develop a tractable structural model with analytical default probabilities depending on some dynamics parameters, and we show how to calibrate the model using a chosen number of Credit Default Swap (CDS) market quotes. We essentially show how to use structural models with a calibration capability that is typical of the much more tractable credit-spread based intensity models.

We apply the structural model to a concrete calibration case and observe what happens to the calibrated dynamics when the CDS-implied credit quality deteriorates as the firm approaches default. Finally we provide a typical example of a case where the calibrated structural model can be used for credit pricing in a much more convenient way than a calibrated reduced form model: The pricing of counterparty risk in an equity swap.

Keywords: Credit Derivatives, Structural Models, Black Cox Model, Credit Default Swaps, Calibration, Analytical Tractability, Monte Carlo Simulation, Equity Swaps, Counterparty Risk, Barrier Options

JEL Classification: G13

Suggested Citation

Brigo, Damiano and Tarenghi, Marco, Credit Default Swap Calibration and Equity Swap Valuation Under Counterparty Risk with a Tractable Structural Model (August 24, 2004). Available at SSRN: https://ssrn.com/abstract=581302 or http://dx.doi.org/10.2139/ssrn.581302

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Marco Tarenghi (Contact Author)

Mediobanca ( email )

Piazzetta Enrico Cuccia, 1
Milano, MI 20121
Italy

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