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

Abstract EN

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.