A Note on Replicating a CDS Through a Repo and an Asset Swap

Abstract

In this note we show how to replicate a stylized CDS with a repurchase agreement and an asset swap. The latter must be designed in such a way that, on default of the issuer, it is terminated with a zero close-out amount. This break clause can be priced using the well known unilateral credit/debit valuation adjustment formulas.

Keywords: Credit Default Swap, Repurchase agreement, Structured Repo, Term repo, Repo to maturity, Asset swap, Early termination, Break clause, Close-out amount, Credit Valuation Adjustment, Debit Valuation Adjustment, CVA, DVA

JEL Classification: G12, G13