Pricing Credit Default Swaps with Option-Implied Volatility

Posted: 9 Aug 2011 Last revised: 11 Sep 2011

See all articles by Charles Cao

Charles Cao

Pennsylvania State University

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance

Zhaodong Zhong

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: August 9, 2011

Abstract

Using the industry benchmark CreditGrades model to analyze credit default swap (CDS) spreads across a large number of companies during the 2007-09 credit crisis, the authors demonstrate that the performance of the model can be significantly improved by calibrating it with option-implied volatility rather than with historical volatility. Moreover, the advantage of using option-implied volatility is greater among companies with more volatile CDS spreads, more actively traded options, and lower credit ratings.

Keywords: Derivatives, Credit Derivatives Markets and Instruments, Modeling and Pricing Credit Derivatives, Options Markets and Instruments, Volatility Issues

Suggested Citation

Cao, Charles and Yu, Fan and Zhong, Zhaodong, Pricing Credit Default Swaps with Option-Implied Volatility (August 9, 2011). Financial Analysts Journal, Vol. 67, No. 4, 2011. Available at SSRN: https://ssrn.com/abstract=1907319

Charles Cao (Contact Author)

Pennsylvania State University ( email )

Department of Finance
Smeal College of Business
University Park, PA 16802
United States
814-865-7891 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://www.personal.psu.edu/qxc2/cao.html

Fan Yu

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States
(909)607-3345 (Phone)

HOME PAGE: http://www.cmc.edu/academic/faculty/profile.asp?Fac=553

Zhaodong Zhong

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

Department of Finance, Rutgers Business School
100 Rockafeller Road
Piscataway, NJ 08854
United States

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