PT  - JOURNAL ARTICLE
AU  - Janne Kettunen
AU  - Gunter Meissner
TI  - Valuing Credit Default Swaps on Correlated LMM Processes
AID  - 10.3905/jai.2006.640268
DP  - 2006 Jun 30
TA  - The Journal of Alternative Investments
PG  - 78--88
VI  - 9
IP  - 1
4099  - https://pm-research.com/content/9/1/78.short
4100  - https://pm-research.com/content/9/1/78.full
AB  - The article derives a model with a closed form solution for valuing default swaps including reference asset—counterparty default correlation. The default correlation between the reference asset and the counterparty is incorporated in two quadruple trees. One tree represents the default swap payoff of the default swap seller; the other tree represents the default swap premium payments of the default swap buyer. Swap valuation techniques are then applied to derive the fair default swap price. The model is combined with three LMM (Libor Market Model) processes. One LMM process simulates risk-free short-term interest rates. Two other LMM processes generate the reference asset default probabilities and the counterparty default probabilities. Two examples of the model are provided. In one model the default swap premium is paid upfront (at the beginning of each period) whereas in the other model the default swap premium is paid in arrears (at the end of each period).TOPICS: Credit default swaps, statistical methods, credit risk management