Pricing credit default swaps under a multi-scale stochastic volatility model

In this paper, we consider the pricing of credit default swaps (CDSs) with the reference asset driven by a geometric Brownian motion with a multi-scale stochastic volatility (SV), which is a two-factor volatility process with one factor controlling the fast time scale and the other representing the slow time scale. A key feature of the current methodology is to establish an equivalence relationship between the CDS and the down-and-out binary option through the discussion of “no default” probability, while balancing the two SV processes with the perturbation method. An approximate but closed-form pricing formula for the CDS contract is finally obtained, whose accuracy is in the order of O(ϵ+δ+ϵδ).