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Valuation of Credit Contingent Options with Applications to Quanto CDS

19 Pages Posted: 30 Jun 2008 Last revised: 20 Nov 2013

Anlong Li

Portunes LLC

Date Written: November 12, 2013


We study the valuation of credit-contingent asset or options by modelling the correlation between asset price and credit default. We provide three ways of modelling such correlation: (1) asset value follows a diffusion process with a one-time jump (such as currency devaluation) at the time of credit default; (2) Default intensity and asset price are driven by correlated Brownian motions in addition to the jump; (3) Default time and future asset price are correlated through a copula. When both asset price and credit default are independent of interest rates, such contract can be valued on a two-dimensional lattice (or finite-difference grid) in the second approach. We show that for a large class of one-factor default rate models, the computation can be reduced to one-dimension, a property often reserved for the affine class of models. We also obtain analytical solutions if default hazard rate, asset price return, and the copula are all Gaussian. Our experience shows that valuation is much more sensitive to the first and third type of correlations. We apply the model to the valuation of extinguishable FX swaps that terminate upon a credit event and quanto credit default swaps where premium and protection legs are paid in different currencies.

Keywords: Credit Derivatives, Quanto CDS, Extingushable Cross Currency Swap, Credit Correlaton, Jump Diffusion, Copula, Currency Devaluation

JEL Classification: G13

Suggested Citation

Li, Anlong, Valuation of Credit Contingent Options with Applications to Quanto CDS (November 12, 2013). Available at SSRN: or

Anlong Li (Contact Author)

Portunes LLC ( email )

1410 N State Pkwy Apt 19a
chicago, IL 60610-4938
United States

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