A Multivariate jump diffusion process for counterparty risk in CDS rates

Siti Norafidah Mohd Ramli, Jiwook Jang

Research output: Contribution to journalArticle

Abstract

We consider counterparty risk in CDS rates. To do so, we use a multivariate jump diffusion process for obligors' default intensity, where jumps (i.e. magnitude of contribution of primary events to default intensities) occur simultaneously and their sizes are dependent. For these simultaneous jumps and their sizes, a homogeneous Poisson process. We apply copula-dependent default intensities of multivariate Cox process to derive the joint Laplace transform that provides us with joint survival/default probability and other relevant joint probabilities. For that purpose, the piecewise deterministic Markov process (PDMP) theory developed in [7] and the martingale methodology in [6] are used. We compute survival/default probability using three copulas, which are Farlie-Gumbel-Morgenstern (FGM), Gaussian and Student-t copulas, with exponential marginal distributions. We then apply the results to calculate CDS rates assuming deterministic rate of interest and recovery rate. We also conduct sensitivity analysis for the CDS rates by changing the relevant parameters and provide their figures.
Original languageEnglish
Pages (from-to)23-45
Number of pages23
JournalJournal of the Korea Society for Industrial and Applied Mathematics
Volume19
Issue number1
DOIs
Publication statusPublished - 2015

Keywords

  • multivariate jump diffusion process
  • multivariate Cox process
  • joint survival/default probability
  • copulas
  • counterparty risk
  • CDS rate

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