Pricing default swaps: Empirical evidence [An article from: Journal of International Money and Finance]

by P. Houweling, T. Vorst

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This digital document is a journal article from Journal of International Money and Finance, published by Elsevier in . The article is delivered in HTML format and is available in your Amazon.com Media Library immediately after purchase. You can view it with any web browser.

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In this paper we compare market prices of credit default swaps with model prices. We show that a simple reduced form model outperforms directly comparing bonds' credit spreads to default swap premiums. We find that the model yields unbiased premium estimates for default swaps on investment grade issuers, 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 relatively insensitive to the value of the assumed recovery rate.

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