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Computing the survival probability in the Madan–Unal credit risk model: application to the CDS market

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  • Luca Vincenzo Ballestra
  • Graziella Pacelli
  • Davide Radi

Abstract

We obtain a quasi-analytical approximation of the survival probability in the credit risk model proposed in [Madan, D.B. and Unal, H., Pricing the risk of default. Rev. Deriv. Res., 1998, 2(2), 121–160]. Such a formula, which extensive numerical simulations reveal to be accurate and computationally fast, can also be employed for pricing credit default swaps (CDSs). Specifically, we derive a quasi-analytical approximate expression for CDS par spreads, and we use it to estimate the parameters of the model. The results obtained show a rather satisfactory agreement between theoretical and real market data.

Suggested Citation

  • Luca Vincenzo Ballestra & Graziella Pacelli & Davide Radi, 2017. "Computing the survival probability in the Madan–Unal credit risk model: application to the CDS market," Quantitative Finance, Taylor & Francis Journals, vol. 17(2), pages 299-313, February.
    • Handle: RePEc:taf:quantf:v:17:y:2017:i:2:p:299-313
    DOI: 10.1080/14697688.2016.1189590
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    Cited by:

    1. 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.
    2. Giulia Livieri & Davide Radi & Elia Smaniotto, 2023. "Pricing Transition Risk with a Jump-Diffusion Credit Risk Model: Evidences from the CDS market," Papers 2303.12483, arXiv.org.
    3. Ballestra, Luca Vincenzo & Pacelli, Graziella & Radi, Davide, 2020. "Modeling CDS spreads: A comparison of some hybrid approaches," Journal of Empirical Finance, Elsevier, vol. 57(C), pages 107-124.
    4. Feng-Hui Yu & Jiejun Lu & Jia-Wen Gu & Wai-Ki Ching, 2019. "Modeling Credit Risk with Hidden Markov Default Intensity," Computational Economics, Springer;Society for Computational Economics, vol. 54(3), pages 1213-1229, October.

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