The Pricing of Credit Default Swaps During Distress
AbstractCredit default swaps (CDS) provide the buyer with insurance against certain types of credit events by entitling him to exchange any of the bonds permitted as deliverable against their par value. Unlike bonds, whose risk spreads are assumed to be the product of default risk and loss rate, CDS are par instruments, and their spreads reflect the partial recovery of the delivered bond's face value. This paper addresses the implications of the difference between bond and CDS spreads and shows the extent to which the recovery assumption matters for determining CDS spreads. A no-arbitrage argument is applied to extract recovery rates from CDS and bond markets, using data from Brazil's distress in 2002-03. Results are related to the observation that preemptive restructurings are now more common than straight defaults in sovereign bond markets and that this leads to a decoupling of CDS and bond spreads.
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Bibliographic InfoPaper provided by International Monetary Fund in its series IMF Working Papers with number 06/254.
Date of creation: 01 Nov 2006
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-01-06 (All new papers)
- NEP-CFN-2007-01-06 (Corporate Finance)
- NEP-FMK-2007-01-06 (Financial Markets)
- NEP-IAS-2007-01-06 (Insurance Economics)
- NEP-MIC-2007-01-06 (Microeconomics)
- NEP-MST-2007-01-06 (Market Microstructure)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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