A Model for Counterparty Risk with Geometric Attenuation Effect and the Valuation of CDS.pdfVIP

A Model for Counterparty Risk with Geometric Attenuation Effect and the Valuation of CDS Yunfen BAI †‡ , Xinhua HU† Zhongxing YE† 7 † Department of Mathematics, Shanghai Jiaotong University, Shanghai 200240, China 0 0 ‡ Department of Mathematics, Shijiazhuang College, Shijiazhuang, Hebei 050035, China 2 n January, 2007 u J 2 2 Abstract: In this paper, a geometric function is introduced to reflect the attenuation speed of impact of one firm’s default to its partner. If two firms are competitions (copartners), the ] R default intensity of one firm will decrease (increase) abruptly when the other firm defaults. P As time goes on, the impact will decrease gradually until extinct. In this model, the joint . h distribution and marginal distributions of default times are derived by employing the change t of measure, so can we value the fair swap premium of a CDS. a m Key words: Dependent default; Geometric attenuation function; Change of measure; Credit [ Default Swap(CDS) 1 v 2000 Mathematics Subject Classification: 62P05 1 3 3 3 1. Introduction . 6 The rapid expansion in recent years of market for the credit derivatives had led to a growing 0 interest in the valuation of these instruments including the credit default swaps(CDS).The refer- 7 0 ence issuers and the derivative issuers not only have default risk, but also correlate in some way. : As remarked by Jarrow and Yu (2001),”an investigation of coun