Abstract
We study the pricing of defaultable derivatives, such as bonds, bond options, and credit default swaps in the reduced form framework of intensity‐based models. We use regular and singular perturbation expansions on the intensity of default from which we derive approximations for the pricing functions of these derivatives. In particular, we assume an Ornstein‐Uhlenbeck process for the interest rate, and a two‐factor diffusion model for the intensity of default. The approximation allows for computational efficiency in calibrating the model. Finally, empirical evidence on the existence of multiple scales is presented by the calibration of the model on corporate yield curves. Work partially supported by NSF grants DMS‐0306357 and DMS‐0456195.
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