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.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by International Monetary Fund in its series IMF Working Papers with number 06/254.
Date of creation: 01 Nov 2006
Date of revision:
Contact details of provider:
Postal: International Monetary Fund, Washington, DC USA
Phone: (202) 623-7000
Fax: (202) 623-4661
Web page: http://www.imf.org/external/pubind.htm
More information through EDIRC
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.:
- Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005.
"Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market,"
Journal of Finance,
American Finance Association, vol. 60(5), pages 2213-2253, October.
- Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
- Amadou N. R. Sy & Andrea Pescatori, 2004. "Debt Crises and the Development of International Capital Markets," IMF Working Papers 04/44, International Monetary Fund.
- Franck Packer & Haibin Zhu, 2005. "Contractual terms and CDS pricing," BIS Quarterly Review, Bank for International Settlements, March.
- 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.).
- Frank Packer & Chamaree Suthiphongchai, 2003. "Sovereign credit default swaps," BIS Quarterly Review, Bank for International Settlements, December.
- Didier Cossin & Tomas Hricko & Daniel Aunon-Nerin & Zhijiang Huang, 2002. "Exploring for the Determinants of Credit Risk in Credit Default Swap Transaction Data: Is Fixed-Income Markets’ Information Suffcient to Evaluate Credit Risk?," FAME Research Paper Series rp65, International Center for Financial Asset Management and Engineering.
- Christian Capuano, 2008. "The Option-Ipod. the Probability of Default Implied by Option Prices Basedon Entropy," IMF Working Papers 08/194, International Monetary Fund.
- Michael Adler & Jeong Song, 2010. "The behavior of emerging market sovereigns' credit default swap premiums and bond yield spreads," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 31-58.
- Ammer, John & Cai, Fang, 2011. "Sovereign CDS and bond pricing dynamics in emerging markets: Does the cheapest-to-deliver option matter?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(3), pages 369-387, July.
- Christoph Trebesch & Michael G Papaioannou & Udaibir S. Das, 2012. "Sovereign Debt Restructurings 1950-2010," IMF Working Papers 12/203, International Monetary Fund.
- Christoph Trebesch, 2009. "The Cost of Aggressive Sovereign Debt Policies," IMF Working Papers 09/29, International Monetary Fund.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jim Beardow) or (Hassan Zaidi).
If references are entirely missing, you can add them using this form.