Pricing and trading credit default swaps in a hazard process model

TL;DR

This paper analyzes the dynamics of credit default swap prices within a hazard process model, deriving their behavior without assuming the immersion property, and explores replicating defaultable claims through dynamic trading strategies.

Contribution

It introduces a novel approach to modeling CDS price dynamics without the immersion property and applies it to the replication of defaultable claims.

Findings

Derived CDS price dynamics without the immersion property

Studied replication of defaultable claims using CDS trading

Provided insights into credit risk modeling and hedging strategies

Abstract

In the paper we study dynamics of the arbitrage prices of credit default swaps within a hazard process model of credit risk. We derive these dynamics without postulating that the immersion property is satisfied between some relevant filtrations. These results are then applied so to study the problem of replication of general defaultable claims, including some basket claims, by means of dynamic trading of credit default swaps.