Levy Processes in Credit Risk

Acknowledgements.

PART I: INTRODUCTION.

1 An Introduction to Credit Risk.

1.1 Credit Risk.

1.1.1 Historical and Risk-Neutral Probabilities.

1.1.2 Bond Prices and Default Probability.

1.2 Credit Risk Modelling.

1.3 Credit Derivatives.

1.4 Modelling Assumptions.

1.4.1 Probability Space and Filtrations.

1.4.2 The Risk-Free Asset.

2 An Introduction to Lévy Processes.

2.1 Brownian Motion.

2.2 Lévy Processes.

2.3 Examples of Lévy Processes.

2.3.1 Poisson Process.

2.3.2 Compound Poisson Process.

2.3.3 The Gamma Process.

2.3.4 Inverse Gaussian Process.

2.3.5 The CMY Process.

2.3.6 The Variance Gamma Process.

2.4 Ornstein–Uhlenbeck Processes.

2.4.1 The Gamma-OU Process.

2.4.2 The Inverse Gaussian-OU Process.

PART II: SINGLE-NAME MODELLING.

3 Single-Name Credit Derivatives.

3.1 Credit Default Swaps.

3.1.1 Credit Default Swaps Pricing.

3.1.2 Calibration Assumptions.

3.2 Credit Default Swap Forwards.

3.2.1 Credit Default Swap Forward Pricing.

3.3 Constant Maturity Credit Default Swaps.

3.3.1 Constant Maturity Credit Default Swaps Pricing.

3.4 Options on CDS.

4 Firm-Value Lévy Models.

4.1 The Merton Model.

4.2 The Black–Cox Model with Constant Barrier.

4.3 The Lévy First-Passage Model.

4.4 The Variance Gamma Model.

4.4.1 Sensitivity to the Parameters.

4.4.2 Calibration on CDS Term Structure Curve.

4.5 One-Sided Lévy Default Model.

4.5.1 Wiener–Hopf Factorization and Default Probabilities.

4.5.2 Illustration of the Pricing of Credit Default Swaps.

4.6 Dynamic Spread Generator.

4.6.1 Generating Spread Paths.

4.6.2 Pricing of Options on CDSs.

4.6.3 Black’s Formulas and Implied Volatility.

Appendix: Solution of the PDIE.

5 IntensityLévy Models.

5.1 Intensity Models for Credit Risk.

5.1.1 Jarrow–Turnbull Model.

5.1.2 Cox Models.

5.2 The Intensity-OU Model.

5.3 Calibration of the Model on CDS Term Structures.

PART III: MULTIVARIATE MODELLING.

6 Multivariate Credit Products.

6.1 CDOs.

6.2 Credit Indices.

7 Collateralized Debt Obligations.

7.1 Introduction.

7.2 The Gaussian One-Factor Model.

7.3 Generic One-Factor Lévy Model.

7.4 Examples of Lévy Models.

7.5 Lévy Base Correlation.

7.5.1 The Concept of Base Correlation.

7.5.2 Pricing Non-Standard Tranches.

7.5.3 Correlation Mapping for Bespoke CDOs.

7.6 Delta-Hedging CDO tranches.

7.6.1 Hedging with the CDS Index.

7.6.2 Delta-Hedging with a Single-Name CDS.

7.6.3 Mezz-Equity hedging.

8 Multivariate Index Modelling.

8.1 Black’s Model.

8.2 VG Credit Spread Model.

8.3 Pricing Swaptions using FFT.

8.4 Multivariate VG Model.

PART IV: EXOTIC STRUCTURED CREDIT RISK PRODUCTS.

9 Credit CPPIs and CPDOs.

9.1 Introduction.

9.2 CPPIs.

9.3 Gap Risk.

9.4 CPDOs.

10 Asset-Backed Securities.

10.1 Introduction.

10.2 Default Models.

10.2.1 Generalized Logistic Default Model.

10.2.2 Lévy Portfolio Default Model.

10.2.3 Normal One-Factor Default Model.

10.2.4 Generic One-Factor Lévy Default Model.

10.3 Prepayment Models.

10.3.1 Constant Prepayment Model.

10.3.2 Lévy Portfolio Prepayment Model.

10.3.3 Normal One-Factor Prepayment Model.

10.4 Numerical Results.

Bibliography.

Index.