Credit default swap calibration and derivatives pricing with the SSRD stochastic intensity model (Q1776023)

The two-dimensional shifted square-root diffusion (SSRD) model for interest-rate and credit derivatives in presence of stochastic intensity is introduced. The important feature of this model is the possible correlation between the interest rate and the default intensity (related to the credit spread). It is possibly the unique explicit model providing positive intensities and interest rates that can be exactly and analytically calibrated to the term structure of interest rates and credit default swaps (CDS's). Some parameters remain to be used to calibrate cap options data in the interest-rate market and possible options on CDS's on the credit derivatives market. Calibration to two markets can be kept separately, which is of practical value and ensures consistency between different desks of a financial institution. A new positivity preserving implicit Euler scheme for Monte Carlo simulation is proposed. The impact of interest-rate and default-intensity correlation is discussed and an analytical approximation to price some basic credit derivatives terms involving CIR processes is developed.