Applications To Credit Risk Modeling
The variance gamma process has been successfully applied in the modeling of credit risk in structural models. The pure jump nature of the process and the possibility to control skewness and kurtosis of the distribution allow the model to price correctly the risk of default of securities having a short maturity, something that is generally not possible with structural models in which the underlying assets follow a Brownian motion. Fiorani, Luciano and Semeraro model credit default swaps under variance gamma. In an extensive empirical test they show the overperformance of the pricing under variance gamma, compared to alternative models presented in literature.
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