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Linear Credit Risk Models

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  • Damien Ackerer
  • Damir Filipovi'c

Abstract

We introduce a novel class of credit risk models in which the drift of the survival process of a firm is a linear function of the factors. The prices of defaultable bonds and credit default swaps (CDS) are linear-rational in the factors. The price of a CDS option can be uniformly approximated by polynomials in the factors. Multi-name models can produce simultaneous defaults, generate positively as well as negatively correlated default intensities, and accommodate stochastic interest rates. A calibration study illustrates the versatility of these models by fitting CDS spread time series. A numerical analysis validates the efficiency of the option price approximation method.

Suggested Citation

  • Damien Ackerer & Damir Filipovi'c, 2016. "Linear Credit Risk Models," Papers 1605.07419, arXiv.org, revised Jul 2019.
    • Handle: RePEc:arx:papers:1605.07419
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    References listed on IDEAS

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    1. Tomasz Bielecki & Monique Jeanblanc & Marek Rutkowski, 2011. "Hedging of a credit default swaption in the CIR default intensity model," Finance and Stochastics, Springer, vol. 15(3), pages 541-572, September.
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    Cited by:

    1. Peter Carr & Sander Willems, 2019. "A lognormal type stochastic volatility model with quadratic drift," Papers 1908.07417, arXiv.org.
    2. Damien Ackerer & Thibault Vatter, 2016. "Dependent Defaults and Losses with Factor Copula Models," Papers 1610.03050, arXiv.org, revised Jan 2018.
    3. Christa Cuchiero & Sara Svaluto-Ferro, 2019. "Infinite dimensional polynomial processes," Papers 1911.02614, arXiv.org.
    4. Damir Filipović & Martin Larsson, 2016. "Polynomial diffusions and applications in finance," Finance and Stochastics, Springer, vol. 20(4), pages 931-972, October.
    5. Sander Willems, 2019. "Linear Stochastic Dividend Model," Papers 1908.05850, arXiv.org, revised Aug 2019.

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