PDE Approach to Valuation and Hedging of Credit Derivatives

by Tomasz R. Bielecki of the Illinois Institute of Technology,
Monique Jeanblanc of the Université d'Évry Val d'Essonne, and
Marek Rutkowski of the University of New South Wales & Warsaw University of Technology

June 2005

Abstract: This paper presents a PDE approach in a Markovian setting to hedge defaultable derivatives. The arbitrage price and the hedging strategy for an attainable contingent claim are described in terms of solutions of a pair of coupled PDEs. For some standard examples of defaultable claims, we provide explicit formulae for prices and hedging strategies.

Keywords: Credit derivatives, Hedging, Valuation, PDE approach.

Published in: Quantitative Finance, Vol. 5, No. 3, (June 2005), pp. 257-270.

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