An Empirical Comparison of Alternative Credit Default Swap Pricing Models

64 Pages Posted: 23 Oct 2012

Date Written: September 21, 2012

Abstract

Most of the important models in finance rest on the assumption that randomness is explained through a normal random variable because, in general, the use of alternative models is obstructed by the difficulty of calibrating and simulating them. In this paper, we empirically study models for pricing credit default swaps under a reduced-form framework, assuming different dynamics for the default intensity process. After reviewing the most recent results on this subject, we explore both pricing performance and parameter stability during the highly volatile period from 30 June 2008 to 31 December 2010 for different classes of processes: one driven by the Brownian motion, three driven by non-Gaussian Lévy processes, and the last one driven by a Sato process. The models are analysed from both a static and dynamic perspective.

Keywords: credit default swap, Cox-Ingersoll-Ross, non-Gaussian Ornstein-Uhlenbeck processes, Lévy processes, Sato processes, filtering methods, unscented Kalman filter, particle filter

JEL Classification: C46, C58, C61

Suggested Citation

Bianchi, Michele Leonardo, An Empirical Comparison of Alternative Credit Default Swap Pricing Models (September 21, 2012). Bank of Italy Temi di Discussione (Working Paper) No. 882, Available at SSRN: https://ssrn.com/abstract=2165842 or http://dx.doi.org/10.2139/ssrn.2165842

Michele Leonardo Bianchi (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Rome, I - 00184
Italy

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