Pricing Credit Default Swaps Under Multifactor Reduced-Form Models: A Differential Quadrature Approach

We present a new numerical method for pricing credit default swaps under fully correlated multifactor reduced-form models. In particular, the proposed approach combines an implicit/explicit operator splitting procedure with the harmonic differential quadrature scheme, and is so efficient that it can...

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Bibliographic Details
Published in:Computational economics 2018-03, Vol.51 (3), p.379-406
Main Authors: Andreoli, Alessandro, Ballestra, Luca Vincenzo, Pacelli, Graziella
Format: Article
Language:English
Subjects:
Behavioral/Experimental Economics
Collateralized debt obligations
Computer Appl. in Social and Behavioral Sciences
Computer simulation
Credit
Credit default swaps
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
International finance
Math Applications in Computer Science
Mathematical analysis
Mathematical models
Numerical analysis
Operations Research/Decision Theory
Pricing
Simulation
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Summary:We present a new numerical method for pricing credit default swaps under fully correlated multifactor reduced-form models. In particular, the proposed approach combines an implicit/explicit operator splitting procedure with the harmonic differential quadrature scheme, and is so efficient that it can be applied to models with up to six stochastic factors. This is a remarkable advantage, as we can use two factors to describe the interest rate, other two factors to describe the default probability, and other two factors to take into account, for example, the so-called counterparty risk. The performances of the novel method are demonstrated by extensive simulation, in which various kinds of models with four and six fully correlated factors are considered.
ISSN:0927-7099
1572-9974
DOI:10.1007/s10614-016-9608-x