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Default barrier intensity model for credit risk evaluation

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  • Elhiwi, Majdi

Abstract

We establish the Default Barrier Intensity (DBI) model, based on the conditional survival probability (also called hazard function barrier), which allows the pricing of credit derivatives with stochastic parameters. Moreover, the DBI is an analytic model which combines the structural and the reduced form approaches. It deals with the impact of the default barrier intensity on the processes around the firm. Using this model we prove the Doob–Meyer decomposition of the default process associated with the random barrier. In this framework, we present the default barrier process as the sum of its compensator (which is a predictable process) and a martingale related to the smallest filtration making the random barrier a stopping time. Furthermore, the DBI as well as the Shifted Square Root Diffusion (SSRD) Alfonsi’s model emphasizes on the dependence between the stochastic default intensity and the interest rate. This model can be useful since it can be easily generalized to all the credit derivatives products such as Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS).

Suggested Citation

  • Elhiwi, Majdi, 2014. "Default barrier intensity model for credit risk evaluation," Statistics & Probability Letters, Elsevier, vol. 95(C), pages 125-131.
    • Handle: RePEc:eee:stapro:v:95:y:2014:i:c:p:125-131
    DOI: 10.1016/j.spl.2014.08.008
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    References listed on IDEAS

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    8. Tomasz R. Bielecki & Monique Jeanblanc & Marek Rutkowski, 2006. "Hedging of Credit Derivatives in Models with Totally Unexpected Default," World Scientific Book Chapters, in: Jiro Akahori & Shigeyoshi Ogawa & Shinzo Watanabe (ed.), Stochastic Processes And Applications To Mathematical Finance, chapter 2, pages 35-100, World Scientific Publishing Co. Pte. Ltd..
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