A structural approach to pricing credit default swaps with credit and debt value adjustments

TL;DR

This paper introduces a multi-dimensional structural model for pricing credit default swaps that accounts for credit and debt value adjustments, using semi-analytical methods to handle complex calibration and pricing problems.

Contribution

It extends structural default models to multiple dimensions with a Marshall-Olkin-inspired correlation, providing new semi-analytical solutions for calibration and pricing.

Findings

Effective modeling of bilateral counterparty risk in CDS

Accurate evaluation of credit and debt value adjustments

Enhanced calibration techniques for multi-dimensional models

Abstract

A multi-dimensional extension of the structural default model with firms' values driven by diffusion processes with Marshall-Olkin-inspired correlation structure is presented. Semi-analytical methods for solving the forward calibration problem and backward pricing problem in three dimensions are developed. The model is used to analyze bilateral counterparty risk for credit default swaps and evaluate the corresponding credit and debt value adjustments.