Pricing credit default swaps with Parisian and Parasian default mechanics

Publication Name

Communications in Statistics: Simulation and Computation

Abstract

This paper proposes Parisian and Parasian default mechanics for modeling the credit risks of the CDS (credit default swap) contracts. Unlike most of the structural models used in the literature, our new model assumes that the default will occur only if the price of the reference asset stays below a certain level for a pre-described period of time. To work out the corresponding CDS price, a general pricing formula containing the unknown no-default probability is derived first. It is then shown that the determination of such a probability is equivalent to the valuation of a Parisian or Parasian down-and-out binary options, depending on how the time is recorded. After the option price is solved with a θ finite difference scheme, the CDS price is obtained through the derived general pricing formula. Finally, some numerical experiments are carried out to study the effects of the new default mechanics on the CDS prices.

Open Access Status

This publication may be available as open access

Volume

51

Issue

2

First Page

421

Last Page

431

Funding Number

2017ZSJD020

Funding Sponsor

National Natural Science Foundation of China

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Link to publisher version (DOI)

http://dx.doi.org/10.1080/03610918.2019.1653913