An Empirical Comparison of Default Swap Pricing Models

55 Pages Posted: 3 Nov 2009

See all articles by Patrick Houweling

Patrick Houweling

Robeco Investment Research

Ton Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management; Tinbergen Institute

Date Written: February 27, 2002

Abstract

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

Keywords: credit default swaps, credit risk, default risk, market prices, credit derivatives, default-free interest rates, empirical models

JEL Classification: C13, G12, M, G13, G3

Suggested Citation

Houweling, Patrick and Vorst, Ton A.C.F., An Empirical Comparison of Default Swap Pricing Models (February 27, 2002). ERIM Report Series Reference No. ERS-2002-23-F&A, Available at SSRN: https://ssrn.com/abstract=1498915

Patrick Houweling

Robeco Investment Research ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands
+31-10-2243538 (Phone)

HOME PAGE: http://www.robeco.com/quant

Ton A.C.F. Vorst

VU University Amsterdam - Department of Finance and Financial Sector Management ( email )

De Boelelaan 1105
NL-1081HV Amsterdam
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

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