On Reduced Form Intensity-based Model with Trigger Events

TL;DR

This paper introduces a novel reduced-form intensity-based credit risk model that incorporates trigger events and economic factors, providing a more realistic framework for default analysis and pricing of credit derivatives.

Contribution

It develops a new model combining trigger events with economic environment effects in a Cox process framework, applicable to single and multiple defaults.

Findings

Derived explicit default time distribution for single-default case

Applied model to price defaultable bonds

Extended model to multi-name Credit Default Swaps

Abstract

Corporate defaults may be triggered by some major market news or events such as financial crises or collapses of major banks or financial institutions. With a view to develop a more realistic model for credit risk analysis, we introduce a new type of reduced-form intensity-based model that can incorporate the impacts of both observable "trigger" events and economic environment on corporate defaults. The key idea of the model is to augment a Cox process with trigger events. Both single-default and multiple-default cases are considered in this paper. In the former case, a simple expression for the distribution of the default time is obtained. Applications of the proposed model to price defaultable bonds and multi-name Credit Default Swaps (CDSs) are provided.