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Implementing a Structural Valuation Model of Swap Credit-Sensitive Rates

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Author Info
Hugues Pirotte () (Centre Emile Bernheim, Solvay Business School, Université Libre de Bruxelles, Brussels)

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Abstract

Currency and interest rate swaps are subject to a complex, two-sided default risk. Several theoretical papers have addressed the problem of pricing swap credit risk. I propose a complete implementation procedure of the structural line of research in theoretical credit risk analysis in order to attempt to evaluate an OTC contract such as the swap contract. It is shown how structural models can enable us to extract the whole credit risk information from scarce data if of good quality, which leads to the problem of mixing accounting and available financial data from traded prices. Ther analytical results are therefore benchmarked against actual transaction data. Although the results are not very satisfactory for swap pricing, the procedure provides interesting insights in some parameter estimations linked to the credit worthiness of the firm that show to be consistent indicators, useful for credit risk management purposes.

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File URL: http://www.solvay.edu/EN/Research/Bernheim/documents/wp99001.pdf
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File Function: First version, 1999
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Publisher Info
Paper provided by Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB) in its series Working Papers CEB with number 99-001.RS.

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Length: 34 pages
Date of creation: Dec 1999
Date of revision:
Handle: RePEc:sol:wpaper:99-001

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Related research
Keywords: derivatives; swaps; credit risk; transaction data; model calibration.;

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Find related papers by JEL classification:
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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  1. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July. [Downloadable!] (restricted)
  2. Gregory R. Duffee, 1995. "The variation of default risk with treasury yields," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 29-58.
  3. Didier Cossin & Hugues Pirotte, 1998. "How well do classical credit risk pricing models fit swap transaction data?," European Financial Management, Blackwell Publishing Ltd, vol. 4(1), pages 65-77. [Downloadable!] (restricted)
    Other versions:
  4. Campbell, John Y, 1986. " A Defense of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 41(1), pages 183-93, March. [Downloadable!] (restricted)
    Other versions:
  5. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March. [Downloadable!] (restricted)
  6. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May. [Downloadable!] (restricted)
  7. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May. [Downloadable!] (restricted)
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  8. Hugues Pirotte, 1999. "A Structural Model of the Term Structure of Credit Spreads with Stochastic Recovery and Contractual Design," Working Papers CEB 99-002.RS, Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB). [Downloadable!]
  9. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March. [Downloadable!] (restricted)
  10. Longstaff, Francis A & Schwartz, Eduardo S, 1995. " A Simple Approach to Valuing Risky Fixed and Floating Rate Debt," Journal of Finance, American Finance Association, vol. 50(3), pages 789-819, July. [Downloadable!] (restricted)
  11. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-49, July. [Downloadable!] (restricted)
  12. Jesus Saa-Requejo & Pedro Santa-Clara, 1997. "Bond Pricing with Default Risk," University of California at Los Angeles, Anderson Graduate School of Management 1127, Anderson Graduate School of Management, UCLA. [Downloadable!]
  13. Ronn, Ehud I & Verma, Avinash K, 1986. " Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-95, September. [Downloadable!] (restricted)
  14. Cossin, Didier & Pirotte, Hugues, 1997. "Swap credit risk: An empirical investigation on transaction data," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1351-1373, October. [Downloadable!] (restricted)
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