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We propose a novel credit default model that takes into account the impact of macroeconomic information and contagion effect on the defaults of obligors. We use a set-valued Markov chain to model the default process, which is the set of all defaulted obligors in the group. We obtain analytic characterizations for the default process, and use them to derive pricing formulas in explicit forms for synthetic collateralized debt obligations (CDOs). Furthermore, we use market data to calibrate the model and conduct numerical studies on the tranche spreads of CDOs. We find evidence to support that systematic default risk coupled with default contagion could have the leading component of the total default risk.
We introduce the general arbitrage-free valuation framework for counterparty risk adjustments in presence of bilateral default risk, including default of the investor. We illustrate the symmetry in the valuation and show that the adjustment involves
We consider a general tractable model for default contagion and systemic risk in a heterogeneous financial network, subject to an exogenous macroeconomic shock. We show that, under some regularity assumptions, the default cascade model could be trans
The 2008 financial crisis has been attributed to excessive complexity of the financial system due to financial innovation. We employ computational complexity theory to make this notion precise. Specifically, we consider the problem of clearing a fina
This work presents a theoretical and empirical evaluation of Anderson-Darling test when the sample size is limited. The test can be applied in order to backtest the risk factors dynamics in the context of Counterparty Credit Risk modelling. We show t
Groups of enterprises can serve as guarantees for one another and form complex networks when obtaining loans from commercial banks. During economic slowdowns, corporate default may spread like a virus and lead to large-scale defaults or even systemic