Hostname: page-component-76fb5796d-skm99 Total loading time: 0 Render date: 2024-04-27T04:34:13.791Z Has data issue: false hasContentIssue false
  • English
  • Français

The Valuation of Default-Triggered Credit Derivatives

Published online by Cambridge University Press:  06 April 2009

Ren-Raw Chen  and
Ben J. Sopranzetti
Ren-Raw Chen
Affiliation:
rchen@rci.rutgers.edu, Department of Finance and Economics, School of Business, Rutgers University, 94 Rockafeller Road, Piscataway, NJ 08854
Ben J. Sopranzetti
Affiliation:
sopranze@rci.rutgers.edu, Department of Finance and Economics, School of Business, Rutgers University, 94 Rockafeller Road, Piscataway, NJ 08854.
Get access Rights & Permissions [Opens in a new window]

Abstract

Credit derivatives are among the fastest growing contracts in the derivatives market. We present a simple, easily implementable model to study the pricing and hedging of two widely traded default-triggered claims: default swaps and default baskets. In particular, we demonstrate how default correlation (the correlation between two default processes) impacts the prices of these claims. When we extend our model to continuous time, we find that, once default correlation has been taken into consideration, the spread dynamics have very little explanatory power.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 2 , June 2003 , pp. 359 - 382
Copyright
Copyright © School of Business Administration, University of Washington 2003

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Collin-Dufresne, P., and Solnik, B.. “On the Term Structure of Default Premia in the Swap and LIBOR Markets.” Journal of Finance, 56 (2001), 1095–1116.Google Scholar
Das, S.; Fong, G.; and Geng, G.. “Impact of Correlated Default Risk on Credit Portfolios.” Journal of Fixed Income, 3 (2001), 9–19.Google Scholar
Duffie, D. “First to Default Valuation.” Working Paper, Stanford Univ. (1998a).Google Scholar
Duffie, D.. “Credit Swap Valuation.” Working Paper, Stanford Univ. (1998b).Google Scholar
Duffie, D., and Singleton, K.. “Econometric Modeling of Term Structure of Defaultable Bonds.” Review of Financial Studies, 12 (1999a), 687–720.CrossRefGoogle Scholar
Duffie, D.. “Simulating Correlated Defaults.” Working Paper, Stanford Univ. (1999b).Google Scholar
Hull, J.Options, Futures, and Other Derivatives, 4th ed.Englewood Cliffs, NJ: Prentice Hall (1999).Google Scholar
Hull, J., and White, A.. “Valuing Credit Default Swaps II: Modeling Default Correlations.” Journal of Derivatives, 8 (2001), 12–22.CrossRefGoogle Scholar
Jarrow, R., and Turnbull, S.. “Pricing Options on Financial Securities Subject to Default Risk.” Journal of Finance, 50 (1995), 53–86.CrossRefGoogle Scholar
Jarrow, R.; Lando, D.; and Turnbull, S.. “A Markov Model for the Term Structure of Credit Risk Spreads.” Review of Financial Studies, 10 (1997), 481–523.CrossRefGoogle Scholar
Lando, D. “On Cox Processes and Credit Risky Securities.” Review of Derivatives Research, 2 (1998), 99–120.CrossRefGoogle Scholar
Li, D. “On Default Correlation: A Copula Function Approach.” Journal of Fixed Income, 9 (2000), 43–54.Google Scholar
Longstaff, F., and Schwartz, E.. “A Simple Approach to Valuing Risky Fixed and Floating Rate Debt.” Journal of Finance, 50 (1995), 789–820.CrossRefGoogle Scholar
Madan, D., and Unal, H.. “Pricing the Risks of Defaults.” Working Paper, Univ. of Maryland (1993).Google Scholar
Merton, R. “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–470.Google Scholar
Nielsen, S., and Ronn, E.. “The Valuation of Default Risk in Corporate Bonds and Interest Rate Swaps.” Working Paper, Univ. of Texas at Austin (1995).Google Scholar
Reyfman, A., and Toft, K.. “Default Swap Investment Strategies.” Goldman Sachs Fixed Income Research: Credit Derivative Strategies (2001).Google Scholar
Schweizer, B., and Wolff, E.. “On Non-parametric Measure of Dependence for Random Variables.” Annals of Statistics, 9 (1981), 879–885.Google Scholar
Zhou, C. “An Analysis of Default Correlations and Multiple Defaults.” Review of Financial Studies, 14 (2001), 555–576.CrossRefGoogle Scholar