Pricing Irs With Unilateral Default Risk Based On No-Arbitrage Model

With the development and strengthening of financial liberalization and globalization,the world’s financial markets become linked. Changes in the international market willhave an effect on a country’s interest rate. Interest rate swaps （IRS） can manage interestrate well and its cost is low. While IRS is used to manage risk, it can cause new risks.Considering the default risk in the process of pricing IRS can enhance its market liquidityand expand the size of transactions. The purpose of this paper is to build IRS’ pricingmodel based on no-arbitrage model with unilateral default risk, combining with thedevelopment of IRS’ transactions and the current situation of pricing IRS.In this paper, we use the BDT and Hull-White Model, which are frequently useddynamic model of interest rate, to build pricing model of IRS with unilateral default risk.We describe the pricing process of IRS using normative and empirical analysis, analyze thefactors which have an effect on IRS’ price, and use quantitative method to analyze pricingprocess and measure default risk. Using the inter-bank bond yield curve, SHIBOR curve,and R007in the China’s financial market, we have an empirical analysis of pricing model.And then we also compare the pricing results of bond equivalent method and zero-couponpricing method based on BDT and Hull-White method with the results of usual method. Theresults show that the results of pricing method based on BDT and Hull-White methoddemonstrate the consistent characteristics, and have small gap comparing with the publishedpricing in the www. Chinamoney.com. The pricing method based on BDT and Hull-Whitemethod increase the flexibility of pricing IRS.