Efficient solution of structural default models with correlated jumps and mutual obligations

DOI10.1080/00207160.2015.1071360MaRDI QIDQ2804497zbMATH OpenOpenAlexFDO

Authors Andrey Itkin, Alexander Lipton

Publication date 29 April 2016

Published in International Journal of Computer Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1408.6513

zbMATH Keywords

matrix exponentialsplittingjoint survival probabilityPIDEmarginal survival probabilitymutual liabilitiesstructural default modelLévy processes

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Monte Carlo methods (65C05) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) PDEs in connection with game theory, economics, social and behavioral sciences (35Q91) Credit risk (91G40) Integro-partial differential equations (35R09) Finite difference methods for initial value and initial-boundary value problems involving PDEs (65M06) Financial applications of other theories (91G80)

Abstract: The structural default model of Lipton and Sepp, 2009 is generalized for a set of banks with mutual interbank liabilities whose assets are driven by correlated Levy processes with idiosyncratic and common components. The multi-dimensional problem is made tractable via a novel computational method, which generalizes the one-dimensional fractional partial differential equation method of Itkin, 2014 to the two- and three-dimensional cases. This method is unconditionally stable and of the second order of approximation in space and time; in addition, for many popular Levy models it has linear complexity in each dimension. Marginal and joint survival probabilities for two and three banks with mutual liabilities are computed. The effects of mutual liabilities are discussed, and numerical examples are given to illustrate these effects.

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Cited in

(12)

• Integrated structural approach to credit value adjustment
• Structural default model with mutual obligations
• Modelling stochastic skew of FX options using SLV models with stochastic spot/vol correlation and correlated jumps
• Three non-Gaussian models of dependence in returns
• Circulant preconditioning technique for barrier options pricing under fractional diffusion models
• Multivariate FX models with jumps: triangles, quantos and implied correlation
• Semi-analytical solution of a McKean-Vlasov equation with feedback through hitting a boundary
• Transition probability of Brownian motion in the octant and its application to default modelling
• LSV models with stochastic interest rates and correlated jumps
• Modern monetary circuit theory, stability of interconnected banking network, and balance sheet optimization for individual banks
• A fast algorithm for numerical solutions to Fortet's equation
• Old problems, classical methods, new solutions

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