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arXiv · 1603.02902

Interacting Default Intensity with Hidden Markov Process

Feng-Hui Yu·Wai-Ki Ching·Jia-Wen Gu·Tak-Kuen Siu
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Abstract

In this paper we consider a reduced-form intensity-based credit risk model with a hidden Markov state process. A filtering method is proposed for extracting the underlying state given the observation processes. The method may be applied to a wide range of problems. Based on this model, we derive the joint distribution of multiple default times without imposing stringent assumptions on the form of default intensities. Closed-form formulas for the distribution of default times are obtained which are then applied to solve a number of practical problems such as hedging and pricing credit derivatives. The method and numerical algorithms presented may be applicable to various forms of default intensities.

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Feng-Hui Yu, Wai-Ki Ching, Jia-Wen Gu, Tak-Kuen Siu. 2016-03-09. Interacting Default Intensity with Hidden Markov Process. https://arxiv.org/abs/1603.02902

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