We study the fair valuation of participating life insurance policies with surrender guarantees when an early default mechanism is imposed by a regulator. An insurance company is forced to be liquidated once a solvency threshold is reached before maturity. The early default regulation affects the contracts’ value not only directly via changing the contracts’ payment streams but also indirectly v...

Motivated by recent financial crises in East Asia and the U.S. where the downfall of a small number of firms had an economy-wide impact, this paper generalizes existing reduced-form models to include default intensities dependent on the default of a counterparty. In this model, firms have correlated defaults due not only to an exposure to common risk factors, but also to firm-specific risks tha...

The credit derivatives market has experienced remarkable growth over the past decade. As such, there is a growing interest in tools for pricing of the most prominent credit derivative, the credit default swap (CDS). In this paper, we propose a heuristic algorithm for pricing of basket default swaps (BDS). For this purpose, genetic network programming (GNP), which is one of the recent evolutiona...

We propose a hierarchical Marshall-Olkin model of countrywide systemic risk. At the lower level, we model the systemic risk of a crisis within the banking system (that we call “within” systemic risk) and at the higher level we model the probability of a joint default of the banking system and the public sector (that we call “between” systemic risk). As for the within systemic risk, we propose a...

We study the effect of risk aversion on the valuation of credit derivatives. Using the technology of utility-indifference valuation in intensity-based models of default risk, we analyze resulting yield spreads for single-name defaultable bonds, and a simple representative two-name credit derivative. The impact of risk averse valuation on prices and yield spreads is expressed in terms of effecti...

We apply the default density framework developed in El Karoui et al. [8] to modelling of multiple defaults, which can be adapted to both top-down and bottom-up models. We present general pricing results and establish links with the classical intensity approach. Explicit models are also proposed by using the methods of change of probability measure or dynamic copula.

We consider a reduced-form credit risk model where default intensity and interest rate are linear functions of a not fully observable Markovian factor process. We determine arbitragefree prices of OTC products coherently with information from the financial market, in particular yields and credit spreads and this can be accomplished via a linear filtering approach coupled with an EM -algorithm f...

In Crépey (2015, Part II), a basic reduced-form counterparty risk modeling approach was introduced, under a rather standard immersion hypothesis between a reference filtration and the filtration progressively enlarged by the default times of the two parties, also involving the continuity of some of the data at default time. This basic approach is too restrictive for application to credit deriva...

We propose implied spreads (IS) and normalized (NIS) as simple measures to characterize option prices. IS is the credit spread of an option’s bond, portfolio long a risk-free bond short put option. NIS normalizes by risk-neutral default probability reflects tail risk. are countercyclical predict returns, while neither, like volatility, predicts returns. These opposite predictability results con...