Solving Stochastic Differential Equations with Jump-Diffusion Efficiently: Applications to FPT Problems in Credit Risk

Details Solving Stochastic Differential Equations with Jump-Diffusion Efficiently: Applications to FPT Problems in Credit Risk Solving Stochastic Differential Equations with Jump-Diffusion Efficiently: Applications to FPT Problems in Credit Risk

2007-02-28

arxiv.org/abs/cs/0702166v1

Computer Science

Computational Engineering, Finance, and Science

Keywords: Default Correlation, First Passage Time, Multivariate Jump-Diffusion Processes, Monte-Carlo Simulation, Multivariate

Scientific paper

The first passage time (FPT) problem is ubiquitous in many applications. In finance, we often have to deal with stochastic processes with jump-diffusion, so that the FTP problem is reducible to a stochastic differential equation with jump-diffusion. While the application of the conventional Monte-Carlo procedure is possible for the solution of the resulting model, it becomes computationally inefficient which severely restricts its applicability in many practically interesting cases. In this contribution, we focus on the development of efficient Monte-Carlo-based computational procedures for solving the FPT problem under the multivariate (and correlated) jump-diffusion processes. We also discuss the implementation of the developed Monte-Carlo-based technique for multivariate jump-diffusion processes driving by several compound Poisson shocks. Finally, we demonstrate the application of the developed methodologies for analyzing the default rates and default correlations of differently rated firms via historical data.

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