Journal of Computational Finance

Risk.net

Recursive valuation of Basket Default Swaps

Ian Iscoe, Alex Kreinin

ABSTRACT

In this paper we consider an analytical valuation of Basket Default Swaps. Our solution is based on a continuous-time model in a conditional independence framework. We use the order statistics of the default times of the names in the basket to find a recursive algorithm for computation of the risk-neutral distribution of the default process of the basket. We derive an analytical expression for the value of the first-to-default swap, which leads to a solution for an mth-to-default swap, using the recursive algorithm. The accuracy and performance of the analytical method are compared with that obtained using Monte Carlo simulation.

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