Pricing Default Swaps: Empirical Evidence

49 Pages Posted: 24 Dec 2001  

Patrick Houweling

Robeco Investment Research

Ton Vorst

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

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, risk-neutral valuation, default-free interest rates

JEL Classification: G12, G13, C13

Suggested Citation

Houweling, Patrick and Vorst, Ton, Pricing Default Swaps: Empirical Evidence. Journal of International Money and Finance, Vol. 24, pp. 1200-1225, 2005; EFA 2002 Berlin Meetings Presented Paper; EFMA 2002 London Meetings; ERIM Report Series. Available at SSRN: https://ssrn.com/abstract=294799 or http://dx.doi.org/10.2139/ssrn.294799

Patrick Houweling (Contact Author)

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 - Tinbergen Institute Amsterdam (TIA) ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Paper statistics

Downloads
4,759
Rank
1,158
Abstract Views
15,476