Default risk in interest rate derivatives with stochastic volatility.

Kim, Bomi; Kim, Jeong-Hoon

In this study, we consider short interest rate models of the Vascicek type with stochastic volatility and obtain formulas for default risk in interest rate derivatives. Corrections from a fast mean-reverting stochastic volatility are computed to show how they can affect the term structure of the interest rate derivatives. Our results for the defaultable bonds as well as the corresponding bond options are obtained as an extension of the non-defaultable case studied by Cotton et al. [Math. Finance, 2004, 14(2), 173–200].

MARKET volatility; ARBITRAGE pricing theory; CREDIT risk; CREDIT derivatives; INTEREST rates; STOCHASTIC analysis; BONDS (Finance); DEFAULT (Finance)

Quantitative Finance, 2011, Vol 11, Issue 12, p1837

1469-7688

Academic Journal

10.1080/14697688.2010.543426