Pricing of Interest Rate Swap Derivatives for Assuring Credit Rating Migration

Abstract:

Considering the valuation of a protected swap on credit rating migration, under the framework of structural methods, a pricing model was established for protecting the loss caused by the first credit rating migration, where the credit ratings depend on the interest rate and have two grades. In the pricing model, an independent variable of the model was defined by the value of lowgrade zerocoupon, which is a new perspective. A partial differential equation(PDE) pricing model was derived by the hedging method. A semiclosed solution was obtained by dimensionality reduction technique. The numerical solution was calculated by the explicit finite difference method. Finally, the dependency of parameters of the model was discussed and the results show that there is a monotonically decreasing relationship between premium value and each parameter.