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Abstract and Applied Analysis
Volume 2014 (2014), Article ID 412890, 12 pages
http://dx.doi.org/10.1155/2014/412890
Research Article

Total Return Swap Valuation with Counterparty Risk and Interest Rate Risk

1School of Business Information, Shanghai University of International Business and Economics, Shanghai 201620, China
2Department of Mathematics, Shanghai Jiaotong University, Shanghai 200240, China

Received 17 January 2014; Accepted 28 April 2014; Published 28 May 2014

Academic Editor: Imran Naeem

Copyright © 2014 Anjiao Wang and Zhongxing Ye. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

We study the pricing of total return swap (TRS) under the contagion models with counterparty risk and the interest rate risk. We assume that interest rate follows Heath-Jarrow-Morton (HJM) forward interest rate model and obtain the Libor market interest rate. The cases where default is related to the interest rate and independent of interest rate are considered. Using the methods of change of measure and the “total hazard construction,” the joint default probabilities are obtained. Furthermore, we obtain the closed-form formulas of TRS under different contagion models, respectively.