Pricing basket default swaps in a tractable shot noise model

Alexander Herbertsson*, Jiwook Jang, Thorsten Schmidt

*Corresponding author for this work

Research output: Contribution to journalArticle

9 Citations (Scopus)

Abstract

We value CDS spreads and kth-to-default swap spreads in a tractable shot noise model. The default dependence is modelled by letting the individual jumps of the default intensity be driven by a common latent factor. The arrival of the jumps is driven by a Poisson process. By using conditional independence and properties of the shot noise processes we derive tractable closed form expressions for the default distribution and the ordered survival distributions. These quantities are then used to price kth-to-default swap spreads. We calibrate a homogeneous version of the model to the term structure on market data from the iTraxx Europe index series sampled during the period 2008-01-14 to 2010-02-11. We perform 435 calibrations in this turbulent period and almost all calibrations yield very good fits. Finally we study kth-to-default spreads in the calibrated model.

Original languageEnglish
Pages (from-to)1196-1207
Number of pages12
JournalStatistics and Probability Letters
Volume81
Issue number8
DOIs
Publication statusPublished - Aug 2011

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