Risk Premia and Optimal Liquidation of Credit Derivatives
30 Pages Posted: 13 Oct 2011 Last revised: 28 Oct 2015
Date Written: September 25, 2012
Abstract
This paper studies the optimal timing to liquidate credit derivatives in a general intensity-based credit risk model under stochastic interest rate. We incorporate the potential price discrepancy between the market and investors, which is characterized by risk-neutral valuation under different default risk premia specifications. We quantify the value of optimally timing to sell through the concept of delayed liquidation premium, and analyze the associated probabilistic representation and variational inequality. We illustrate the optimal liquidation policy for both single-named and multi-named credit derivatives. Our model is extended to study the sequential buying and selling problem with and without short-sale constraint.
Keywords: optimal stopping, derivatives liquidation, price discrepancy, default risk premia
JEL Classification: G12, G13, C68
Suggested Citation: Suggested Citation
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