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The pricing of credit default swaps under a generalized mixed fractional Brownian motion

In this paper, we consider the pricing of the CDS (credit default swap) under a GMFBM (generalized mixed fractional Brownian motion) model. As the name suggests, the GMFBM model is indeed a generalization of all the FBM (fractional Brownian motion) models used in the literature, and is proved to be...

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Bibliographic Details
Published in:Physica A 2014-06, Vol.404, p.26-33
Main Authors: He, Xinjiang, Chen, Wenting
Format: Article
Language:English
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Summary:In this paper, we consider the pricing of the CDS (credit default swap) under a GMFBM (generalized mixed fractional Brownian motion) model. As the name suggests, the GMFBM model is indeed a generalization of all the FBM (fractional Brownian motion) models used in the literature, and is proved to be able to effectively capture the long-range dependence of the stock returns. To develop the pricing mechanics of the CDS, we firstly derive a sufficient condition for the market modeled under the GMFBM to be arbitrage free. Then under the risk-neutral assumption, the CDS is fairly priced by investigating the two legs of the cash flow involved. The price we obtained involves elementary functions only, and can be easily implemented for practical purpose. Finally, based on numerical experiments, we analyze quantitatively the impacts of different parameters on the prices of the CDS. Interestingly, in comparison with all the other FBM models documented in the literature, the results produced from the GMFBM model are in a better agreement with those calculated from the classical Black–Scholes model. •The pricing of the CDS is considered under a GMFBM model.•A sufficient condition for the GMFBM to be arbitrary free is derived.•The impacts of different parameters on the prices of the CDS are analyzed.
ISSN:0378-4371
1873-2119
DOI:10.1016/j.physa.2014.02.046