Contagion models with interacting default intensity processes

Credit risk is quantified by the loss distribution due to unexpected changes in the credit quality of the counterparty in a financial contract. Default correlation risk refers to the risk that a bundle of risky obligors may default together. To understand the clustering phenomena in correlated defaults, we consider credit contagion models which describe the propagation of financial distress from one risky obligor to another. We present the contagion model of portfolio credit risk of multiple obligors with interacting default intensity processes where the default of one firm may trigger the increase of default intensity of other related firms. As an application, we consider how correlated default risks between the protection seller and the underlying entity may affect the credit default premium in a credit default swap. 2000 Mathematics Subject Classification: 60G55, 62M05.