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Non-linear Gaussian sovereign CDS pricing models / Marco Realdon

Quantitative Finance, Pages: 1 - 20

Swansea University Author: Marco Realdon

Abstract

Prior literature indicates that quadratic models and the Black-Karasinki model are very promising for CDS pricing. This paper extends these models and the Black (1995) model for pricing sovereign CDS’s. Default intensity, default loss and liquidity intensity are all driven by Gaussian factors.For al...

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Published in: Quantitative Finance
ISSN: 1469-7688 1469-7696
Published: 2018
Online Access: Check full text

URI: https://cronfa.swan.ac.uk/Record/cronfa39362
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Abstract: Prior literature indicates that quadratic models and the Black-Karasinki model are very promising for CDS pricing. This paper extends these models and the Black (1995) model for pricing sovereign CDS’s. Default intensity, default loss and liquidity intensity are all driven by Gaussian factors.For all ten sovereigns in the sample quadratic models best fit CDS spreads, although also the Black-Karasinki and Black models perform well. Fourfactor quadratic models can best account for the joint effects on sovereign CDS spreads of default risk, default loss risk and liquidity risk, as no restriction to factors correlation is needed. Different specifications of CDS liquidity risk are tested and the best specification varies with the sovereign. For some sovereigns the Black model fares better thanBlack-Karasinki, but the opposite is true for other sovereigns.
Keywords: sovereign CDS pricing, discrete time quadratic model, Black model, Black-Karasinski model, method of lines, Extended Kalman Filter
Start Page: 1
End Page: 20