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An Empirical Comparison of Default Swap Pricing Models

  • Houweling, P.
  • Vorst, A.C.F.

Abstract: 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. Keywords: credit default swaps, credit derivatives, credit risk, default risk, default-free interest rates

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Paper provided by Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam in its series ERIM Report Series Research in Management with number ERS-2002-23-F&A.

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Date of creation: 27 Feb 2002
Date of revision:
Handle: RePEc:ems:eureri:172
Contact details of provider: Postal: RSM Erasmus University & Erasmus School of Economics, PoBox 1738, 3000 DR Rotterdam
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Fax: 31-10-408 9020
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