2017/09/04 by Lijun Bo, Bo, Lijun, Agostino Capponi +3
Economics, Econometrics and Finance · #60H30 #60J25 #60J75 #91B28 #Banking stability, regulation, efficiency #Credit Risk and Financial Regulations #FOS: Economics and business #Risk Management (q-fin.RM) #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.1709.01115
openalex publication_date 2017/09/04 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
We study dynamic hedging of counterparty risk for a portfolio of credit derivatives. Our empirically driven credit model consists of interacting default intensities which ramp up and then decay after the occurrence of credit events. Using the Galtchouk-Kunita-Watanabe decomposition of the counterparty risk price payment stream, we recover a closed-form representation for the risk minimizing strategy in terms of classical solutions to nonlinear recursive systems of Cauchy problems. We discuss applications of our framework to the most prominent class of credit derivatives, including credit swap and risky bond portfolios, as well as first-to-default claims.