Pricing model of interest rate swap with a bilateral default risk

Authors:
Xiaofeng Yang;Jinping Yu;Shenghong Li;Albert Jerry Cristoforo;Xiaohu Yang
Affiliations:
Room 115, Ou Yang Building, Department of Mathematics, Zhejiang University, Hangzhou, Zhejiang Province 310027, China;Room 115, Ou Yang Building, Department of Mathematics, Zhejiang University, Hangzhou, Zhejiang Province 310027, China;Department of Mathematics, Zhejiang University, Hangzhou, Zhejiang Province 310027, China;State Street Corporation, 1 Lincoln Street Boston, MA 02111-2901, USA;Department of Computer Science, Zhejiang University, Hangzhou, Zhejiang Province 310027, China
Venue:
Journal of Computational and Applied Mathematics
Year:
2010

Citing 2
Cited 0

Interest rate swaps under CIR

Journal of Computational and Applied Mathematics - Special Issue: Proceedings of the 10th international congress on computational and applied mathematics (ICCAM-2002)
Modelling Australian interest rate swap spreads by mixture autoregressive conditional heteroscedastic processes

Mathematics and Computers in Simulation

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Abstract

Under the foundation of Duffie & Huang (1996) [7], this paper integrates the reduced form model and the structure model for a default risk measure, giving rise to a new pricing model of interest rate swap with a bilateral default risk. This model avoids the shortcomings of ignoring the dynamic movements of the firm's assets of the reduced form model but adds only a little complexity and simplifies the pricing formula significantly when compared with Li (1998) [10]. With the help of the Crank-Nicholson difference method, we give the numerical solutions of the new model to study the default risk effects on the swap rate. We find that for a one year interest rate swap with the coupon paid per quarter, the variance of the default fixed rate payer decreases from 0.1 to 0.01 only causing about a 1.35%'s increase in the swap rate. This is consistent with previous results.