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Valuation of Loan Credit Default Swaps Correlated Prepayment and Default Risks with Stochastic Recovery Rate

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  • Yuan Wu
  • Jin Liang

Abstract

In this paper, we establish an intensity based multi-factor model to value LCDS. The pricing model incorporates the modeling of default, prepayment and recovery risks. Using one factor model, negative correlation between the default and prepayment intensities and positive correlation between the default intensity and the loss given default are described. The interest rate and the house price are chosen as the relevant factors. Under these assumption, a Cauthy problem of PDE is derived, which has a closed-form solution. Based on the solution, numerical examples are provided.

Suggested Citation

  • Yuan Wu & Jin Liang, 2012. "Valuation of Loan Credit Default Swaps Correlated Prepayment and Default Risks with Stochastic Recovery Rate," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 3(2), pages 60-68, April.
    • Handle: RePEc:jfr:ijfr11:v:3:y:2012:i:2:p:60-68
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    References listed on IDEAS

    as
    1. Jin Liang & Yujing Zhou, 2010. "Valuation of a Basket Loan Credit Default Swap," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 1(1), pages 21-29, December.
    2. Ahn, Dong-Hyun & Gao, Bin, 1999. "A Parametric Nonlinear Model of Term Structure Dynamics," The Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 721-762.
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    Cited by:

    1. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.

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