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An Empirical Comparison of Default Swap Pricing Models

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  • Patrick Houweling

    ()
    (Erasmus University Rotterdam)

  • Ton Vorst

    ()
    (VU University Amsterdam)

Abstract

In this paper we compare market prices of credit default swaps with model prices. We showthat a simple reduced form model with a constant recovery rate outperforms the market practice ofdirectly comparing bonds' credit spreads to default swap premiums. We find that the model workswell for investment grade credit default swaps, but only if we use swap or repo rates as proxy fordefault-free interest rates. This indicates that the government curve is no longer seen as thereference default-free curve. We also show that the model is insensitive to the value of theassumed recovery rate.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 02-004/2.

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Date of creation: 22 Jan 2002
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Handle: RePEc:dgr:uvatin:20020004

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Cited by:
  1. Norden, Lars & Weber, Martin, 2004. "Informational efficiency of credit default swap and stock markets: The impact of credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2813-2843, November.
  2. C.J.M. Kool, 2006. "Financial stability in European banking : the role of common factors," Working Papers 06-13, Utrecht School of Economics.
  3. Jaewon Choi & Or Shachar, 2013. "Did liquidity providers become liquidity seekers?," Staff Reports 650, Federal Reserve Bank of New York.
  4. Mehari Mekonnen Akalu, 2002. "Measuring and Ranking Value Drivers," Tinbergen Institute Discussion Papers 02-043/2, Tinbergen Institute.
  5. Linda Allen & Anthony Saunders, 2003. "A survey of cyclical effects in credit risk measurement model," BIS Working Papers 126, Bank for International Settlements.
  6. da Silva, Paulo Pereira & Rebelo, Paulo Tomaz & Afonso, Cristina, 2013. "Tail dependence of financial stocks and CDS markets: Evidence using copula methods and simulation-based inference," Economics Discussion Papers 2013-52, Kiel Institute for the World Economy.
  7. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004. "An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps," Banco de Espa�a Working Papers 0401, Banco de Espa�a.
  8. Hoi Wong & Tsz Wong, 2007. "Reduced-form Models with Regime Switching: An Empirical Analysis for Corporate Bonds," Asia-Pacific Financial Markets, Springer, vol. 14(3), pages 229-253, September.
  9. Nicholas Apergis & Emmanuel Mamatzakis, 2012. "What Are the Driving Factors behind the Rise of Spreads and CDSs of Euro-area Sovereign Bonds? A FAVAR Model for Greece and Ireland," Economics Working Paper Archive wp_720, Levy Economics Institute, The.
  10. Norden, Lars & Weber, Martin, 2004. "The comovement of credit default swap, bond and stock markets: An empirical analysis," CFS Working Paper Series 2004/20, Center for Financial Studies (CFS).
  11. Lekkos, Ilias, 2007. "Modelling multiple term structures of defaultable bonds with common and idiosyncratic state variables," Journal of Empirical Finance, Elsevier, vol. 14(5), pages 783-817, December.
  12. Haibin Zhu, 2004. "An empirical comparison of credit spreads between the bond market and the credit default swap market," BIS Working Papers 160, Bank for International Settlements.
  13. Norden, Lars & Weber, Martin, 2004. "Informational Efficiency of Credit Default Swap and Stock Markets: The Impact of Credit Rating Announcements," CEPR Discussion Papers 4250, C.E.P.R. Discussion Papers.
  14. Scheicher, Martin, 2003. "Credit Derivatives - Overview and Implications for Monetary Policy and Financial Stability," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 5.
  15. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
  16. Frank X. Zhang, 2003. "What did the credit market expect of Argentina default? Evidence from default swap data," Finance and Economics Discussion Series 2003-25, Board of Governors of the Federal Reserve System (U.S.).
  17. Abel Elizalde, 2006. "Credit Risk Models I: Default Correlation In Intensity Models," Working Papers wp2006_0605, CEMFI.
  18. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer, vol. 26(2), pages 161-191, October.

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