Credit Derivative Theory & Practice – A Credit Primer & Review of the Impact of ISDA Standardization on Credit Default Swap Pricing & Credit Model Calibration

28 Pages Posted: 14 Mar 2018 Last revised: 6 Nov 2018

See all articles by Nicholas Burgess

Nicholas Burgess

University of Oxford, Said Business School

Date Written: November 5, 2018

Abstract

In this paper we review the pricing and model calibration of Credit Default Swaps referring to both the International Swaps and Derivatives Association (ISDA) CDS contract and credit model standardization guidelines. Furthermore we provide an Excel pricing workbook to supplement the materials discussed. The main goal is for this paper to act as a credit primer and to review the impact and purpose of ISDA contract and model standardization on credit pricing and modelling techniques.

We review the Credit Default Swap (CDS) product highlighting contract specifications, terminology and how the product has been standardized for increased liquidity and XVA capital cost reduction. We perform a fundamental review of probability and credit modelling, outlining standard market assumptions and techniques used by traders and other market practitioners. Furthermore we demonstrate how to price CDS contracts, calibrate credit models and discuss the ISDA Standard Model, ISDA Fair Value Model and Bloomberg Fair Value Models in particular. In conclusion we discuss CDS liquidity, the need for credit index proxies to hedge credit risk and outline liquidity alternatives to this such as the use of sector and index CDS contracts.

Keywords: Credit Derivatives, Credit Default Swaps, Credit Index, Credit Event, Credit Tightening, Credit Widening, Survival Probability, Default Probability, Hazard Rate, Loss Given Default (LGD), Recovery Rate, ISDA Standardization, Credit Spread, Par Spread, Risky Annuity, Risky Discount Factor

JEL Classification: F00, F01, G01, G12, G18, G21, G22, G23, G24, G28, G32, G34, G38

Suggested Citation

Burgess, Nicholas, Credit Derivative Theory & Practice – A Credit Primer & Review of the Impact of ISDA Standardization on Credit Default Swap Pricing & Credit Model Calibration (November 5, 2018). Available at SSRN: https://ssrn.com/abstract=3138923 or http://dx.doi.org/10.2139/ssrn.3138923

Nicholas Burgess (Contact Author)

University of Oxford, Said Business School ( email )

Oxford, OX1 5NY
United Kingdom

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