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Sovereign CDS Calibration Under a Hybrid Sovereign Risk Model

Sovereign CDS Calibration Under a Hybrid Sovereign Risk Model The European sovereign debt crisis, started in the second half of 2011, has posed the problem for asset managers, trades and risk managers to assess sovereign default risk. In the reduced form framework, it is necessary to understand the interrelationship between creditworthiness of a sovereign, its intensity to default and the correlation with the exchange rate between the bond’s currency and the currency in which the Credit Default Swap CDS spread are quoted. To do this, we propose a hybrid sovereign risk model in which the intensity of default is based on the jump to default extended constant elasticity variance model. We analyse the differences between the default intensity under the domestic and foreign measure and we compute the default-survival probabilities in the bond’s currency measure. We also give an approximation formula to CDS spread obtained by perturbation theory and provide an efficient method to calibrate the model to CDS spread quoted by the market. Finally, we test the model on real market data by several calibration experiments to confirm the robustness of our method. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Applied Mathematical Finance Taylor & Francis

Sovereign CDS Calibration Under a Hybrid Sovereign Risk Model

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Sovereign CDS Calibration Under a Hybrid Sovereign Risk Model

Abstract

The European sovereign debt crisis, started in the second half of 2011, has posed the problem for asset managers, trades and risk managers to assess sovereign default risk. In the reduced form framework, it is necessary to understand the interrelationship between creditworthiness of a sovereign, its intensity to default and the correlation with the exchange rate between the bond’s currency and the currency in which the Credit Default Swap CDS spread are quoted. To do this, we propose a...
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Publisher
Taylor & Francis
Copyright
© 2018 Informa UK Limited, trading as Taylor & Francis Group
ISSN
1466-4313
eISSN
1350-486X
DOI
10.1080/1350486X.2018.1554447
Publisher site
See Article on Publisher Site

Abstract

The European sovereign debt crisis, started in the second half of 2011, has posed the problem for asset managers, trades and risk managers to assess sovereign default risk. In the reduced form framework, it is necessary to understand the interrelationship between creditworthiness of a sovereign, its intensity to default and the correlation with the exchange rate between the bond’s currency and the currency in which the Credit Default Swap CDS spread are quoted. To do this, we propose a hybrid sovereign risk model in which the intensity of default is based on the jump to default extended constant elasticity variance model. We analyse the differences between the default intensity under the domestic and foreign measure and we compute the default-survival probabilities in the bond’s currency measure. We also give an approximation formula to CDS spread obtained by perturbation theory and provide an efficient method to calibrate the model to CDS spread quoted by the market. Finally, we test the model on real market data by several calibration experiments to confirm the robustness of our method.

Journal

Applied Mathematical Finance – Taylor & Francis

Published: Jul 4, 2018

Keywords: Credit default swap; hybrid credit-equity model; Constant Elasticity of Variance model; asymptotic expansion; foreign exchange rate

References

  • The Pricing of Options and Corporate Liabilities
  • Multi Currency Credit Default Swaps: Quanto Effects and FX Devaluation Jumps
  • A Jump to Default Extended CEV Model: An Application of Bessel Processes
  • The Influence of FX Risk on Credit Spread
  • Analytical Expansions for Parabolic Equations
  • On the Pricing of Corporate Debt: The Risk Structure of Interest Rates
  • Asymptotic Expansions for Degenerate Parabolic Equations