Sensitivity estimates for portfolio credit derivatives using Monte Carlo (Q2271719)

The authors consider credit derivatives tied to a basket (or portfolio) of several underlying names, such as bonds, loans, or credit default swaps. The payoffs of the derivatives depend on the default times of the underlying assets. The sensitivity of the contract value with respect to parameters of the default-time distributions is estimated by likelihood ratio method, pathwise method and Monte Carlo method. Discontinuities introduced by changes in one default time are smoothed by taking conditional expectations given all other default times. The sensitivities with respect to hazard rates in the cases of basket default swaps and collateralized debt obligations are studied. Importance sampling is implemented, and combinations of the estimators with importance sampling are discussed. Some numerical examples are presented.