Pricing Basket CDS under a reduced form credit risk model with regime switching

  Portfolio credit derivatives have attracted a lot of attention over the last decade in the credit risk theory. The key point in the valuation of such financial derivatives is the modeling of the firms’ default times and of the default correlation among them. Reduced form credit risk models are commonly used for this purpose. In such a model, certain correlated relations are constructed to represent the default dependence structure among the default intensity processes. In this paper, we introduced a reduced form credit risk model in which the default dependence structures among default intensity processes are described by the so-called common shocks with regime-switching. We derive some closed-form expressions for the joint distribution of the default times and for the pricing formulas of the basket credit default swaps. We present some numerical results to show the applicable aspects of the proposed model.