Counterparty credit risk under credit risk contagion using time-homogeneous phase-type distribution

• Main Author: Nowicki, Pierre
• Other Authors: Davis, Mark
• Published: Imperial College London 2015
• Subjects: 338.5
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.689112

With the current situation of credit spread contagion illustrated by the European sovereign bonds crisis and the chain reaction triggered by the derivatives books of Lehman Brothers, financial institutions have increasingly focused on pricing and risk management of counterparty credit risk. Recent credit contagion through financial contingent claims highlight the fact that contagion links impact the value of products when investors are exposed to counterparty risk. This thesis plan to build on reduced-form credit risk models to assess the credit risk contagion that is inherent in a obligor multivariate framework. The aim is to evaluate the requirements that are necessary in generating a mathematical framework consistent with the valuation of financial claims, credit and non-credit related, where the parties of those claims exhibit credit risk contagion. By applying a multivariate framework of credit contagion to counterparty credit risk based on a queueing theory, called phase-type distribution, we hope to highlight the benefit of bottom-up models versus top-down ones in terms of extracting information relative to dependence within an identi able obligor set. We will review the mathematical literature in addressing credit dependence modelling in dynamic and static format. This will be the opportunity to value a set of claims under our model to show that claims that contain "credit leverage" are particularly sensible to credit risk contagion and could benefit from our developed framework to gain adequate counterparty credit risk pricing.