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Using Credit Derivatives to Compute Market-Wide Default Probability Term Structures

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Abstract

In this paper we suggest a simple way of backing out market-wide risk-neutral default probability (and default density) distributions from quoted credit default swap (CDS) index spreads. We apply the approach to two market-wide European portfolios represented by two frequently traded iTraxx Europe CDS indexes, and the resulting analytical default probability term structures are updated on a daily basis. We believe such instantaneous default probability term structures to be useful not only for risk managers in commercial banks but also for hedge funds and others involved in speculation and arbitrage as well as for supervisory authorities like central banks in their quest for financial stability.

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  • Byström, Hans, 2005. "Using Credit Derivatives to Compute Market-Wide Default Probability Term Structures," Working Papers 2005:44, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2005_044
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    Cited by:

    1. Augustin, Patrick & Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit Default Swaps: A Survey," Foundations and Trends(R) in Finance, now publishers, vol. 9(1-2), pages 1-196, December.

    More about this item

    Keywords

    iTraxx; credit default swap index; default probability; term structure;

    JEL classification:

    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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