A Coupled Markov Chain approach to risk analysis of credit default swap index products

Details A Coupled Markov Chain approach to risk analysis of credit default swap index products A Coupled Markov Chain approach to risk analysis of credit default swap index products

2009-11-19

arxiv.org/abs/0911.3802v1

Economy

Quantitative Finance

Risk Management

Scientific paper

We apply a Coupled Markov Chain approach to model rating transitions and thereby default probabilities of companies. We estimate parameters by applying a maximum likelihood estimation using a large set of historical ratings. Given the parameters the model can be used to simulate scenarios for joint rating changes of a set of companies, enabling the use of contemporary risk management techniques. We obtain scenarios for the payment streams generated by CDX contracts and portfolios of such contracts. This allows for assessing the risk of the current position held and design portfolios which are optimal relative to the risk preferences of the investor.

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