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A revised version of the Cathcart & El-Jahel model and its application to CDS market

Author

Listed:
  • Davide Radi

    (University of Pisa
    VS̆B–Technical University of Ostrava)

  • Vu Phuong Hoang

    (Politecnico di Milano)

  • Gabriele Torri

    (VS̆B–Technical University of Ostrava
    University of Bergamo)

  • Hana Dvořáčková

    (VS̆B–Technical University of Ostrava)

Abstract

The paper considers the pricing of credit default swaps (CDSs) using a revised version of the credit risk model proposed in Cathcart and El-Jahel (2003). Default occurs either the first time a signaling process breaches a threshold barrier or unexpectedly at the first jump of a Cox process. The intensity of default depends on the risk-free interest rate, which follows a Vasicek process, instead of a Cox-Ingersoll-Ross process as in the original model. This offers two advantages. On the one hand, it allows us to account for negative interest rates which are recently observed, on the other hand, it simplifies the formula for pricing CDSs. The goodness of fit of the model is tested using a dataset of CDS credit spreads related to European companies. The results obtained show a rather satisfactory agreement between theoretical predictions and market data, which is identical to the one obtained with the original model. In addition, the values of the calibrated parameters result to be stable over time and the semi-closed form solution ensures a very fast implementation.

Suggested Citation

  • Davide Radi & Vu Phuong Hoang & Gabriele Torri & Hana Dvořáčková, 2021. "A revised version of the Cathcart & El-Jahel model and its application to CDS market," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 44(2), pages 669-705, December.
    • Handle: RePEc:spr:decfin:v:44:y:2021:i:2:d:10.1007_s10203-021-00350-x
    DOI: 10.1007/s10203-021-00350-x
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