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The Default Risk of Swaps

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Author Info
 Cooper, Ian A
Mello, Antonio S
Abstract

The authors characterize the exchange of financial claims from risky swaps. These transfers are among three groups: shareholders, debtholders, and the swap counterparty. From this analysis, the authors derive equilibrium swap rates and relate them to debt market spreads. They then show that equilibrium swaps in perfect markets transfer wealth from shareholders to debtholders. In a simplified case, the authors obtain closed-form solutions for the value of the default risk in the swap. For interest-rate swaps, they obtain numerical solutions for the equilibrium swap rate, including default risk. The authors compare these with equilibrium debt market default risk spreads. Copyright 1991 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 46 (1991)
Issue (Month): 2 (June)
Pages: 597-620
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Handle: RePEc:bla:jfinan:v:46:y:1991:i:2:p:597-620

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  1. Gregory R. Duffee, 1996. "Treasury yields and corporate bond yield spreads: an empirical analysis," Finance and Economics Discussion Series 96-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Dilip Madan & Haluk Unal, 1996. "Pricing the Risks of Default," Center for Financial Institutions Working Papers 94-16, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  3. Andrew H. Chen & Mohammed M. Chaudhury, 1996. "The Market Value and Dynamic Interest Rate Risk of Swaps," Center for Financial Institutions Working Papers 96-44, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
  4. Stuart M. Turnbull & Jun Yang, 2004. "Modelling the Evolution of Credit Spreads in the United States," Working Papers 04-45, Bank of Canada. [Downloadable!]
  5. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design and Currency Swaps," NBER Working Papers 8746, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Jun Yang, 2008. "Macroeconomic Determinants of the Term Structure of Corporate Spreads," Working Papers 08-29, Bank of Canada. [Downloadable!]
  7. Anurag Gupta & Marti G. Subrahmanyam, 1999. "An Empirical Examination of the Convexity Bias in the Pricing of Interest Rate Swaps," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-001, New York University, Leonard N. Stern School of Business-. [Downloadable!]
  8. Mark Grinblatt, 1995. "An Analytic Solution for Interest Rate Swap Spreads," University of California at Los Angeles, Anderson Graduate School of Management 1144, Anderson Graduate School of Management, UCLA. [Downloadable!]
    Other versions:
  9. Kenneth A. Froot & Jeremy C. Stein, 1996. "Risk Management, Capital Budgeting and Capital Structure Policy for Financial Institutions: An Integrated Approach," NBER Working Papers 5403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  10. Bhagwan Chowdhry & Mark Grinblatt & David K Levine, 2001. "Information Aggregation, Currency Swaps, and the Design of Derivative Securities," Levine's Working Paper Archive 2106, UCLA Department of Economics. [Downloadable!]
    Other versions:
  11. Acharya, Viral V & Carpenter, Jennifer, 2002. "Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy," CEPR Discussion Papers 3328, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  12. M.Z. Apabhai & N.I. Georgikopoulos & D. Hasnip & R.K.D. Jamie & M. Kim, 1999. "Model for the Value of a Business, Some Optimisation Problems in its Operating Procedures and the Valuation of its Debt," OFRC Working Papers Series 1999mf04, Oxford Financial Research Centre. [Downloadable!]
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