An Intensity-Based Approach for Modeling Hedge Fund Equity

This paper analyzes an intensity-based approach for modeling hedge fund (HF) equity. We use the Cox-Ingersoll-Ross (CIR) process to describe the intensity of the HF's default process. The intensity is purposely linked to the assets of the HF and consequently is also used to explain the equity. We examine two different approaches to link assets and intensity and derive closed-form expressions for the firms' equity in both models. We use the Kalman filter to estimate the parameters of the unobservable intensity process. The applicability of the presented methods is demonstrated on real data working with historical series from Merrill Lynch.