Basket Credit Derivative Pricing in a Markov Chain Model with Interacting Intensities

In this paper, we propose a Markov chain model to price basket credit default swap (BCDS) and basket credit-linked note (BCLN) with counterparty and contagion risks. Suppose that the default intensity processes of reference entities and the counterparty are driven by a common external shock as well as defaults of other names in the contracts. The stochastic intensity of the external shock is a Cox process with jumps. We derive recursive formulas for the joint distribution of default times and obtain closed-form premium rates for BCDS and BCLN. Numerical experiments are performed to show how the correlated default risks may affect the premium rates.

Editorial note

This issue of the journal provides contributions to the exploration of subjects related to different areas of research: public and private sectors, capital market, merger and acquisition, corporate governance and risk management. In particular, the issues dealt with concern: external audit in health care organizations, risk reporting and credit derivative disclosure in the banking sector, risk based management control, governance and financial factors in reverse merger, price to earnings ratio and interest rates in the capital market

WORLD FINANCIAL RELATIONS: UNDERSTANDING THE CREDIT DERIVATIVE SWAPS (CDS) DEPENDENCE STRUCTURE

ABSTRACT This study investigates the copula model that best fit to model the dependence structure of Credit Derivative Swaps (CDS) spreads. For the analysis, we consider daily data from the period of January 1, 2009 to December 31, 2014. Regarding the models, we considered Vine copulas and Hierarchical Archimedean copulas, and different families of copulas. Our results indicate that C-Vine copulas, as well Student t family, demonstrated better performance, according to the criteria used to get the dependence structure. The best fit of the dependence structure can avoid the model risk, from the use of an incorrect model.

HEDGING OF CREDIT DERIVATIVES, SYSTEMATIC FLUCTUATION AND BANKING STABILITY IN CHINA

The objective of this paper is to theoretically and empirically identify the effects of hedging and systematic fluctuation on banking stability in China. First, theoretical propositions indicate that the impact of credit derivative hedging and systematic fluctuation on banking stability in China is derived on the basis of a newly established theoretical model. Then, empirical research based on one-stage and two-stage GMM methods suggests that ascending hedging degrees leads to a linearly improving condition for banking stability with respect to overnight lending swap hedging, an improving-then-worsening condition for compensation swaps and an improving–worsening–improving condition for deposit swap hedging; at the same time, the ascending level of systematic fluctuation associated with hedging improves banking stability. Moreover, the trade-off between loan expansion and the stability maintenance of banking sectors can be managed by hedging compensation swaps and overnight lending swaps. In general, the empirical results support the applicability of the theoretical model, and the hedging of certain swaps can be used as a tool for stability maintenance purposes.