Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model

Modelling the evolution of credit spreads using the Cox process within the HJM framework: A CDS option pricing model

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Article ID: iaor20108505
Volume: 208
Issue: 2
Start Page Number: 95
End Page Number: 108
Publication Date: Jan 2011
Journal: European Journal of Operational Research
Authors: , ,
Abstract:

In this paper a simulation approach for defaultable yield curves is developed within the framework. The default event is modelled using the Cox process where the stochastic intensity represents the credit spread. The forward credit spread volatility function is affected by the entire credit spread term structure. The paper provides the defaultable bond and credit default swap option price in a probability setting equipped with a subfiltration structure. The Euler‐Maruyama stochastic integral approximation and the Monte Carlo method are applied to develop a numerical scheme for pricing. Finally, the antithetic variable technique is used to reduce the variance of credit default swap option prices.

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