Default dependence structure effects on the valuation of government guarantees

The paper analyses the problem of evaluating a guarantee contract against default risk in which the guarantor party is defaultable and the default risks of the guarantor and of the borrower are correlated. This problem has several relevant applications within the present sovereign risk crisis. We have investigated the effects of the dependence structure between defaults events within a framework defined by the classical no-arbitrage market approach, considering intensity models driven by Cox processes for the term structure of survival probabilities and copula models to derive the joint distribution of default times. We compare numerical results on the probability of the guarantee being paid, for different values of the default intensities, using the Gaussian and the Marshall-Olkin copulas, finding relevant differencies and counter-intuitive dependence on the correlation parameter.