Stochastic Intensity Modelling for Structured Credit Exotics

by Alexander Chapovsky of Merrill Lynch,
Andrew Rennie of Merrill Lynch, and
Pedro A. C. Tavares of Merrill Lynch

October 12, 2006

Abstract: We propose a class of credit models where we model default intensity as a jump-diffusion stochastic process. We demonstrate how this class of models can be specialised to value multi-asset derivatives such as CDO and CDO ² in an efficient way. We also suggest how it can be adapted to the pricing of option on tranche and leverage tranche deals. We discuss how the model performs when calibrated to the market.

Keywords: credit, stochastic intensity, credit basket, cdo, tranche, leveraged super-senior, tranche option.

Published in: International Journal of Theoretical and Applied Finance, Vol. 10, No. 4, (June 2007), pp. 633-652.

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