RESEARCH ARTICLE

Valuation of CDS counterparty risk under a reduced-form model with regime-switching shot noise default intensities

  • Yinghui DONG , 1 ,
  • Kam Chuen YUEN 2 ,
  • Guojing WANG 3
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  • 1. Department of Mathematics and Physics, Suzhou University of Science and Technology, Suzhou 215009, China
  • 2. Department of Statistics and Actuarial Science, University of Hong Kong, Hong Kong, China
  • 3. Department of Mathematics and Center for Financial Engineering, Soochow University, Suzhou 215006, China

Received date: 05 Nov 2015

Accepted date: 05 Jul 2017

Published date: 30 Sep 2017

Copyright

2017 Higher Education Press and Springer-Verlag GmbH Germany

Abstract

We study the counterparty risk for a credit default swap (CDS) in a regime-switching market driven by an underlying continuous-time Markov chain. We model the default dependence via some correlated Cox processes with regime-switching shot noise intensities containing common shock. Under the proposed model, the general bilateral counterparty risk pricing formula for CDS contracts with the possibility of joint defaults is presented. Based on some expressions for the conditional Laplace transform of the integrated intensity processes, semi-analytical solution for the bilateral credit valuation adjustment (CVA) is derived. When the model parameters satisfy some conditions, explicit formula for the bilateral CVA at time 0 is also given.

Cite this article

Yinghui DONG , Kam Chuen YUEN , Guojing WANG . Valuation of CDS counterparty risk under a reduced-form model with regime-switching shot noise default intensities[J]. Frontiers of Mathematics in China, 2017 , 12(5) : 1085 -1112 . DOI: 10.1007/s11464-017-0656-x

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