Pricing of Swaps with Default Risk

Posted: 12 Oct 2002

See all articles by Haitao Li

Haitao Li

University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business

Abstract

In this paper, I study the valuation of interest rate and currency swaps with default risk under the contingent claim analysis framework. I demonstrate that the traditional approach of pricing swap contracts as exchanges of loans underestimates the value of such contracts to the counterparty with higher credit rating and exaggerates the credit spread required to guard against default risk. Numerical simulations show that the swap rate is not sensitive to counterparty credit rating: for a ten year interest rate swap, a one hundred basis point increase in counterparty bond yield spread results in only about one basis point increase in the swap rate.

Keywords: credit risk, interest rate swaps, currency swaps, contingent claim analysis

JEL Classification: JEL G10, G12, G13

Suggested Citation

Li, Haitao, Pricing of Swaps with Default Risk. Available at SSRN: https://ssrn.com/abstract=328861

Haitao Li (Contact Author)

University of Michigan - Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-615-5475 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

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