Pricing default swaps: empirical evidence
In this paper we compare market prices of credit default swaps with model prices. We show that a simple reduced form model with a constant recovery rate outperforms the market practice of directly comparing bonds' credit spreads to default swap premiums. We find that the model works well for investment grade credit default swaps, but only if we use swap or repo rates as proxy for default-free interest rates. This indicates that the government curve is no longer seen as the reference default-free curve. We also show that the model is insensitive to the value of the assumed recovery rate
|Date of creation:||07 Aug 2003|
|Date of revision:|
|Contact details of provider:|| Postal: Postbus 1738, 3000 DR Rotterdam|
Phone: 31 10 4081111
Web page: http://www.eur.nl/ese
More information through EDIRC
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.:
- Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-49, July.
- Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
- Longstaff, Francis A., 2000. "The term structure of very short-term rates: New evidence for the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 58(3), pages 397-415, December.
- Darrell Duffie & Lasse Heje Pedersen & Kenneth J. Singleton, 2003. "Modeling Sovereign Yield Spreads: A Case Study of Russian Debt," Journal of Finance, American Finance Association, vol. 58(1), pages 119-159, 02.
- Jarrow, Robert A. & Turnbull, Stuart M., 2000. "The intersection of market and credit risk," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 271-299, January.
- 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.
- Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Philipp J. Schönbucher, 2000. "A Libor Market Model with Default Risk," Bonn Econ Discussion Papers bgse15_2001, University of Bonn, Germany.
- Jarrow, Robert A & Lando, David & Turnbull, Stuart M, 1997.
"A Markov Model for the Term Structure of Credit Risk Spreads,"
Review of Financial Studies,
Society for Financial Studies, vol. 10(2), pages 481-523.
- Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453 World Scientific Publishing Co. Pte. Ltd..
- Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- 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.
- Tom Doan, . "RATS programs to replicate CKLS(1992) estimation of interest rate models," Statistical Software Components RTZ00035, Boston College Department of Economics.
- Gurdip Bakshi & Dilip B. Madan & Frank X. Zhang, 2001. "Understanding the role of recovery in default risk models: empirical comparisons and implied recovery rates," Finance and Economics Discussion Series 2001-37, Board of Governors of the Federal Reserve System (U.S.).
- Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
- Pierre Collin-Dufresne, 2001. "On the Term Structure of Default Premia in the Swap and LIBOR Markets," Journal of Finance, American Finance Association, vol. 56(3), pages 1095-1115, 06.
- Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
- Duffie, Darrell, 1996. " Special Repo Rates," Journal of Finance, American Finance Association, vol. 51(2), pages 493-526, June.
- Sanjiv Ranjan Das & Rangarajan K. Sundaram, 2000. "A Discrete-Time Approach to Arbitrage-Free Pricing of Credit Derivatives," Management Science, INFORMS, vol. 46(1), pages 46-62, January.
When requesting a correction, please mention this item's handle: RePEc:ems:eureir:1083. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (RePub)
If references are entirely missing, you can add them using this form.