Valuation Of Credit Derivatives With Default Correlation

Credit derivatives is an important financial tool to effectively disperse,transfer and hedge credit risk.Credit default swap is one of the basic credit derivatives.Recently,the proportion of credit derivatives has increased year by year.The effect of credit default swap is similar to insurance.The buyer of CDS will transfer the risk of default to the seller of CDS by paying a certain premium,which is a good investment tool,but at the same time it faces risk,and the most serious is the risk of the counterparty.Under the Markov chain framework,in case of the credit risk of the counterparty,this paper considers the contagion of the default and the Common Shock,and the default correlation between the protection seller and the underlying entity is modeled by an increment in default intensity upon the occurrence of the external shock event.We only consider the single directional transmission of external shocks to the protection seller and the underlying entity,that is,when external shocks occur,a positive jump will occur for the default intensity of protection seller and the reference entity.The arrival of the shock event is a Cox process whose stochastic intensity is assumed to follow an affine diffusion process with jumps.On this basis,this paper studies how the risk of default between the seller and the underlying entity affects the credit default premium in the credit default swap.Finally,the numerical analysis is carried out.