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Delayed Default Dependency and Default Contagion

by B.S. Balakrishna -- Unaffiliated

May 15, 2007

Abstract: Delayed, hence non-simultaneous, dependent defaults are discussed in a reduced form model. The model is a generalization of a multi-factor model based on simultaneous defaults to incorporate delayed defaults. It provides a natural smoothening of discontinuities in the joint probability densities in models with simultaneous defaults. It is a dynamic model and exhibits default contagion in a multi-factor setting. It admits an efficient Monte Carlo simulation algorithm that can handle heterogeneous collections of credit names. It can be calibrated to provide exact fits to CDX.NA.IG and iTraxx Europe CDOs just as its version with simultaneous defaults.

JEL Classification: G13.

Keywords: Credit Defaults, Default Contagion, Default Clusters, Reduced Form Model, Jump-Process, CDO.

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