Counterparty Risk for Credit Default Swaps: Markov Chain Interacting Intensities Model With Stochastic Intensity
17 Pages Posted: 14 Jul 2009
Date Written: June 20, 2009
Abstract
We analyze the counterparty risk for credit default swaps using the Markov chain model of portfolio credit risk of multiple obligors with interacting default intensity processes. The default correlation between the protection seller and underlying entity is modeled by an increment in default intensity upon the occurrence of an external shock event. The arrival of the shock event is a Cox process whose stochastic intensity is assumed to follow an affine diffusion process with jumps. We examine how the correlated default risks between the protection seller and the underlying entity may affect the credit default premium in a credit default swap.
Keywords: credit default swaps, counterparty risk, Markov chain model
JEL Classification: G12, G13
Suggested Citation: Suggested Citation
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