Title: Benchmark approach for defaultable claims under partial information

Authors: I. Venkat Appal Raju; N. Selvaraju

Addresses: Stat-Math Unit, Indian Statistical Institute, Bangalore Center, Bangalore 560059, India ' Department of Mathematics, Indian Institute of Technology Guwahati, Guwahati 781039, India

Abstract: We study the pricing and hedging of defaultable claims under the benchmark approach, introduced by Platen and Heath (2006), with partial information. The model is considered to be driven by an Ornstein-Uhlenbeck (OU) process. We first convert the partial information model to a complete information model through the innovation process approach by deriving the non-linear filtering equation for the unobservable processes. We then define the total cash flow and use the Schweizer (2008) methodology for hedging the cash flow under the real world probability measure.

Keywords: credit risk; credit derivatives; reduced form models; benchmarking; local risk minimisation; cash flow; defaultable claims; partial information; innovation process; nonlinear filtering equations; unobservable processes; hedging.

DOI: 10.1504/IJFERM.2013.055848

International Journal of Financial Engineering and Risk Management, 2013 Vol.1 No.2, pp.170 - 192

Received: 29 Feb 2012
Accepted: 29 Apr 2013
Published online: 10 Sep 2014 *

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