@article {Mortensen8, author = {Allan Mortensen}, title = {Semi-Analytical Valuation of Basket Credit Derivatives in Intensity-Based Models}, volume = {13}, number = {4}, pages = {8--26}, year = {2006}, doi = {10.3905/jod.2006.635417}, publisher = {Institutional Investor Journals Umbrella}, abstract = {Credit risk models today mostly come from two different families: structural models and reduced-form, or intensity-based, models. In the former, default probabilities are derived from estimates of how far a given firm{\textquoteright}s net asset value is above a critical level at which it would default. Default correlations come from correlation in the underlying firm values. In intensity-based models, default is modeled as the first jump in a pure jump process, with a jump intensity that may be a function of exogenous factors. Default correlation arises from correlation in those factors. The expanding market for {\textquotedblleft}correlation products,{\textquotedblright} such as basket credit derivatives, raises the need to deal explicitly with default correlation; so far, there has been relatively greater emphasis on the structural approach exemplified by the Gaussian copula model. In this article, Mortensen argues that an intensity-based approach can work just as well, or better. He presents a general model in which default intensities are driven by affine jump-diffusion processes, with a common factor that produces correlation among issuers, and one independent idiosyncratic factor per issuer. Calibrating against tranche prices from CDX and iTraxx CDOs, the intensity-based model is shown to be capable of fitting the market better than standard copula methods.TOPICS: Credit risk management, derivatives}, issn = {1074-1240}, URL = {https://jod.pm-research.com/content/13/4/8}, eprint = {https://jod.pm-research.com/content/13/4/8.full.pdf}, journal = {The Journal of Derivatives} }