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Credit Derivatives Pricing With Stochastic Volatility Models

Author

Listed:
  • CARL CHIARELLA

    (Finance Discipline Group, UTS Business School, University of Technology, Sydney, P.O. Box 123, Broadway, NSW 2007, Australia)

  • SAMUEL CHEGE MAINA

    (E.ON Energy Trading SE, Holzstrasse 6, 40221 Dusseldorf, Germany)

  • CHRISTINA NIKITOPOULOS SKLIBOSIOS

    (Finance Discipline Group, UTS Business School, University of Technology, Sydney, P.O. Box 123, Broadway, NSW 2007, Australia)

Abstract

This paper proposes a model for pricing credit derivatives in a defaultable HJM framework. The model features hump-shaped, level dependent, and unspanned stochastic volatility, and accommodates a correlation structure between the stochastic volatility, the default-free interest rates, and the credit spreads. The model is finite-dimensional, and leads (a) to exponentially affine default-free and defaultable bond prices, and (b) to an approximation for pricing credit default swaps and swaptions in terms of defaultable bond prices with varying maturities. A numerical study demonstrates that the model captures stylized various features of credit default swaps and swaptions.

Suggested Citation

  • Carl Chiarella & Samuel Chege Maina & Christina Nikitopoulos Sklibosios, 2013. "Credit Derivatives Pricing With Stochastic Volatility Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(04), pages 1-28.
    • Handle: RePEc:wsi:ijtafx:v:16:y:2013:i:04:n:s0219024913500192
    DOI: 10.1142/S0219024913500192
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    1. Carl Chiarella & Samuel Chege Maina & Christina Nikitopoulos Sklibosios, 2013. "Credit Derivatives Pricing With Stochastic Volatility Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(04), pages 1-28.
    2. Fanelli, Viviana, 2016. "A defaultable HJM modelling of the Libor rate for pricing Basis Swaps after the credit crunch," European Journal of Operational Research, Elsevier, vol. 249(1), pages 238-244.

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