Modelling Bonds & Credit Default Swaps using a Structural Model with Contagion

Details Modelling Bonds & Credit Default Swaps using a Structural Model with Contagion Modelling Bonds & Credit Default Swaps using a Structural Model with Contagion

2007-10-03

arxiv.org/abs/0710.0753v1

Economy

Quantitative Finance

Pricing of Securities

Scientific paper

This paper develops a two-dimensional structural framework for valuing credit default swaps and corporate bonds in the presence of default contagion. Modelling the values of related firms as correlated geometric Brownian motions with exponential default barriers, analytical formulae are obtained for both credit default swap spreads and corporate bond yields. The credit dependence structure is influenced by both a longer-term correlation structure as well as by the possibility of default contagion. In this way, the model is able to generate a diverse range of shapes for the term structure of credit spreads using realistic values for input parameters.

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