Pricing Interest Rate Swap Subject to Bilateral Counterparty Risk

Xiao, Tim (2019): Pricing Interest Rate Swap Subject to Bilateral Counterparty Risk.

Abstract

This paper presents an analytical model for valuing interest rate swaps, subject to bilateral counterparty credit risk. The counterparty defaults are modeled by the reduced-form model as the first jump of a time-inhomogeneous Poisson process. All quantities modeled are market-observable. The closed-form solution gives us a better understanding of the impact of the credit asymmetry on swap value, credit value adjustment, swap rate and swap spread.

• Item Type: MPRA Paper
• Language: English
• Keywords: defaultable interest rate swap, bilateral defaultable claim, credit asymmetry, market models, Black model, LIBOR market model, reduced-form model, credit value adjustment, swap spread.
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

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