doi: 10.3934/jimo.2020003

On correlated defaults and incomplete information

1. 

Advanced Modeling and Applied Computing Laboratory, Department of Mathematics, The University of Hong Kong, Pokfulam Road, Hong Kong, China

2. 

Corresponding author. Department of Mathematics, Southern University of Science and Technology, Shenzhen, China

3. 

Department of Mathematics, Imperial College, London, SW7 2AZ, UK

Received  June 2018 Revised  July 2019 Published  January 2020

In this paper, we study a continuous time structural asset value model for two correlated firms using a two-dimensional Brownian motion. We consider the situation of incomplete information, where the information set available to the market participants includes the default time of each firm and the periodic asset value reports. In this situation, the default time of each firm becomes a totally inaccessible stopping time to the market participants. The original structural model is first transformed to a reduced-form model. Then the conditional distribution of the default time together with the asset value of each name are derived. We prove the existence of the intensity processes of default times and also give the explicit form of the intensity processes. Numerical studies on the intensities of the two correlated names are conducted for some special cases.

Citation: Wai-Ki Ching, Jia-Wen Gu, Harry Zheng. On correlated defaults and incomplete information. Journal of Industrial & Management Optimization, doi: 10.3934/jimo.2020003
References:
[1]

M. Abramowitz and I. Stegun (Eds.), Handbook of Mathematical Functions, US Department of Commerce, 1967. Google Scholar

[2]

T. Aven, A theorem for determining the compensator of a counting process, Scandinavian Journal of Statistics, 12 (1985), 69-72.   Google Scholar

[3]

F. Black and M. Scholes, The pricing of options and corporate liabilities, Journal of Political Economy, 81 (1973), 637-654.  doi: 10.1086/260062.  Google Scholar

[4]

C. Blanchet-Scalliet, A. Cousin and D. Dorobantu, Hitting time for correlated three-dimensional Brownian motion, working paper, 2013. Google Scholar

[5]

C. Blanchet-Scalliet and F. Patras, Counterparty risk valuation for CDS, Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity, WILEY, 2011, 437–456. Google Scholar

[6]

D. Duffie and D. Lando, Term structures and credit spreads with incomplete accounting information, Econometrica, 69 (2001), 633-664.   Google Scholar

[7]

R. J. ElliottM. Jeanblanc and M. Yor, On models of default risk, Mathematical Finance, 10 (2000), 179-195.   Google Scholar

[8]

M. EscobarS. Ferrando and X. Wen, Three dimensional distribution of Brownian motion extrema, Stochastics an International Journal of Probability and Stochastic Processes, 85 (2013), 807-832.  doi: 10.1080/17442508.2012.660942.  Google Scholar

[9]

K. Giesecke, Correlated default with incomplete information, Journal of Banking and Finance, 28 (2004), 1521-1545.   Google Scholar

[10]

K. Giesecke and L. R. Goldberg, Sequential defaults and incomplete information, Journal of Risk, 7 (2004), 1-26.   Google Scholar

[11]

J. GuW. ChingT. Siu and H. Zheng, On pricing basket credit default swaps, Quantitative Finance, 13 (2013), 1845-1854.  doi: 10.1080/14697688.2013.783713.  Google Scholar

[12]

X. GuoR. Jarrow and Y. Zeng, Credit risk models with incomplete information, Mathematics of Operations Research, 34 (2009), 320-332.  doi: 10.1287/moor.1080.0361.  Google Scholar

[13]

M. Harrison, Brownian Motion and Stochastic Flow Systems, John Wiley and Sons, Inc., New York, 1985.  Google Scholar

[14]

S. Iyengar, Hitting lines with two-dimensional Brownian motion, SIAM Journal of Applied Mathematics, 45 (1985), 983-989.  doi: 10.1137/0145060.  Google Scholar

[15]

R. Jarrow and S. Turnbull, Credit Risk: Drawing the Analogy, Risk Magazine, 5, 1992. Google Scholar

[16]

R. Jarrow and S. Turnbull, Pricing options of financial securities subject to default risk, Journal of Finance, 50 (1995), 53-86.   Google Scholar

[17] F. C. Klebaner, Introduction to Stochastic Calculus with Applications, Third edition, Imperial College Press, London, 2012.  doi: 10.1142/p821.  Google Scholar
[18]

S. Kou and H. Zhong, First Passage Times of Two-dimensional Correlated Brownian Motion, presentation at "Nonlinear Expectation, Stochastic Calculus under Knightian Uncertainty, and Related Topics", Institute of Mathematical Sciences, National University of Singapore, Singapore, 3 June - 12 July, 2013. Google Scholar

[19]

R. C. Merton, On the pricing of corporate debt: The risk structure of interest rates, Journal of Finance, 29 (1974), 449-470.  doi: 10.1142/9789814759588_0003.  Google Scholar

[20]

A. Metzler, On the first passage problem for correlated Brownian motion, Statistics and Probability Letters, 80 (2010), 277-284.  doi: 10.1016/j.spl.2009.11.001.  Google Scholar

[21]

L. C. G. Rogers and L. Shepp, The correlation of the maxima of correlated Brownian motions, J. Applied Probability, 43 (2006), 880-883.  doi: 10.1239/jap/1158784954.  Google Scholar

[22]

F. Yu, Correlated defaults in intensity-based models, Mathematical Finance, 17 (2007), 155-173.   Google Scholar

[23]

H. Zheng and L. Jiang, Basket CDS pricing with interacting intensities, Finance and Stochastics, 13 (2009), 445-469.  doi: 10.1007/s00780-009-0091-2.  Google Scholar

show all references

References:
[1]

M. Abramowitz and I. Stegun (Eds.), Handbook of Mathematical Functions, US Department of Commerce, 1967. Google Scholar

[2]

T. Aven, A theorem for determining the compensator of a counting process, Scandinavian Journal of Statistics, 12 (1985), 69-72.   Google Scholar

[3]

F. Black and M. Scholes, The pricing of options and corporate liabilities, Journal of Political Economy, 81 (1973), 637-654.  doi: 10.1086/260062.  Google Scholar

[4]

C. Blanchet-Scalliet, A. Cousin and D. Dorobantu, Hitting time for correlated three-dimensional Brownian motion, working paper, 2013. Google Scholar

[5]

C. Blanchet-Scalliet and F. Patras, Counterparty risk valuation for CDS, Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity, WILEY, 2011, 437–456. Google Scholar

[6]

D. Duffie and D. Lando, Term structures and credit spreads with incomplete accounting information, Econometrica, 69 (2001), 633-664.   Google Scholar

[7]

R. J. ElliottM. Jeanblanc and M. Yor, On models of default risk, Mathematical Finance, 10 (2000), 179-195.   Google Scholar

[8]

M. EscobarS. Ferrando and X. Wen, Three dimensional distribution of Brownian motion extrema, Stochastics an International Journal of Probability and Stochastic Processes, 85 (2013), 807-832.  doi: 10.1080/17442508.2012.660942.  Google Scholar

[9]

K. Giesecke, Correlated default with incomplete information, Journal of Banking and Finance, 28 (2004), 1521-1545.   Google Scholar

[10]

K. Giesecke and L. R. Goldberg, Sequential defaults and incomplete information, Journal of Risk, 7 (2004), 1-26.   Google Scholar

[11]

J. GuW. ChingT. Siu and H. Zheng, On pricing basket credit default swaps, Quantitative Finance, 13 (2013), 1845-1854.  doi: 10.1080/14697688.2013.783713.  Google Scholar

[12]

X. GuoR. Jarrow and Y. Zeng, Credit risk models with incomplete information, Mathematics of Operations Research, 34 (2009), 320-332.  doi: 10.1287/moor.1080.0361.  Google Scholar

[13]

M. Harrison, Brownian Motion and Stochastic Flow Systems, John Wiley and Sons, Inc., New York, 1985.  Google Scholar

[14]

S. Iyengar, Hitting lines with two-dimensional Brownian motion, SIAM Journal of Applied Mathematics, 45 (1985), 983-989.  doi: 10.1137/0145060.  Google Scholar

[15]

R. Jarrow and S. Turnbull, Credit Risk: Drawing the Analogy, Risk Magazine, 5, 1992. Google Scholar

[16]

R. Jarrow and S. Turnbull, Pricing options of financial securities subject to default risk, Journal of Finance, 50 (1995), 53-86.   Google Scholar

[17] F. C. Klebaner, Introduction to Stochastic Calculus with Applications, Third edition, Imperial College Press, London, 2012.  doi: 10.1142/p821.  Google Scholar
[18]

S. Kou and H. Zhong, First Passage Times of Two-dimensional Correlated Brownian Motion, presentation at "Nonlinear Expectation, Stochastic Calculus under Knightian Uncertainty, and Related Topics", Institute of Mathematical Sciences, National University of Singapore, Singapore, 3 June - 12 July, 2013. Google Scholar

[19]

R. C. Merton, On the pricing of corporate debt: The risk structure of interest rates, Journal of Finance, 29 (1974), 449-470.  doi: 10.1142/9789814759588_0003.  Google Scholar

[20]

A. Metzler, On the first passage problem for correlated Brownian motion, Statistics and Probability Letters, 80 (2010), 277-284.  doi: 10.1016/j.spl.2009.11.001.  Google Scholar

[21]

L. C. G. Rogers and L. Shepp, The correlation of the maxima of correlated Brownian motions, J. Applied Probability, 43 (2006), 880-883.  doi: 10.1239/jap/1158784954.  Google Scholar

[22]

F. Yu, Correlated defaults in intensity-based models, Mathematical Finance, 17 (2007), 155-173.   Google Scholar

[23]

H. Zheng and L. Jiang, Basket CDS pricing with interacting intensities, Finance and Stochastics, 13 (2009), 445-469.  doi: 10.1007/s00780-009-0091-2.  Google Scholar

Figure 1.  Default Intensity process $ \lambda_2 $ when $ \tau_1 = 2 $
Figure 2.  Default Intensities of firm B where $ \rho = -0.5 $
Figure 3.  Default Intensity Process $ \lambda_2 $ when $ \rho = 0 $
Figure 4.  Default Intensity Process $ \lambda_2 $ when $ \tau_1 = 2 $ and $ \rho = 0.1 $
Figure 5.  Default Intensity Process $ \lambda_2 $ when $ \tau_1 = 2 $ and $ \rho = -0.1 $
[1]

Nicolas Rougerie. On two properties of the Fisher information. Kinetic & Related Models, , () : -. doi: 10.3934/krm.2020049

[2]

Shengxin Zhu, Tongxiang Gu, Xingping Liu. AIMS: Average information matrix splitting. Mathematical Foundations of Computing, 2020, 3 (4) : 301-308. doi: 10.3934/mfc.2020012

[3]

Anna Abbatiello, Eduard Feireisl, Antoní Novotný. Generalized solutions to models of compressible viscous fluids. Discrete & Continuous Dynamical Systems - A, 2021, 41 (1) : 1-28. doi: 10.3934/dcds.2020345

[4]

Xin Guo, Lexin Li, Qiang Wu. Modeling interactive components by coordinate kernel polynomial models. Mathematical Foundations of Computing, 2020, 3 (4) : 263-277. doi: 10.3934/mfc.2020010

[5]

Yueyang Zheng, Jingtao Shi. A stackelberg game of backward stochastic differential equations with partial information. Mathematical Control & Related Fields, 2020  doi: 10.3934/mcrf.2020047

[6]

Wei Feng, Michael Freeze, Xin Lu. On competition models under allee effect: Asymptotic behavior and traveling waves. Communications on Pure & Applied Analysis, 2020, 19 (12) : 5609-5626. doi: 10.3934/cpaa.2020256

[7]

Yongge Tian, Pengyang Xie. Simultaneous optimal predictions under two seemingly unrelated linear random-effects models. Journal of Industrial & Management Optimization, 2020  doi: 10.3934/jimo.2020168

[8]

Annegret Glitzky, Matthias Liero, Grigor Nika. Dimension reduction of thermistor models for large-area organic light-emitting diodes. Discrete & Continuous Dynamical Systems - S, 2020  doi: 10.3934/dcdss.2020460

2019 Impact Factor: 1.366

Article outline

Figures and Tables

[Back to Top]