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Successive Correlated Defaults: Pricing trends and simulation

by Kay Giesecke of Cornell University

April 30, 2003

Abstract: We generalize the structural incomplete observation models of default proposed by Duffie & Lando (2001) and Giesecke (2001b) to the multifirm case with correlated defaults. Our approach accommodates the well-documented cyclical correlation effects as well as default cascading effects, which are implied by the incomplete information of investors. We explicitly construct the pricing trend and the intensity of the first, second, etc. default. These results furnish the well-known intensity based price representations of various multi-name credit derivatives and structured credit products. Based on the pricing trend, we also formulate an algorithm for the simulation of successive, correlated, and unpredictable default arrival times.

JEL Classification: G12, G13.

Keywords: correlated defaults, incomplete information, pricing trend, intensity, simulation.

Previously titled: Compensator Based Simulation of Correlated Defaults

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