A Lattice Approach for Pricing Asset Swaps and Default Swaps with Counterparty Risks

In this paper we incorporate the counterparty risk concept of the Jarrow and Yu (2001) continuous-time model into the Hung and Wang (2002) lattice framework to develop a binomial model for valuing default swaps and asset swaps on convertible bonds with counterparty risks. The advantage in using our model is easily implemented for practitioners since the needed parameters in our model can be deduced from the market data of the term structures for the risk-free and risky bonds. From the simulation results, we find that both the default and counterparty risks play important roles in determining the values of asset swaps and default swaps.