# Tag Info

8

It is helpful to think of the yield $r_b$ of a risky bond (say a corporate) in your country as the yield of the risk-free government bond $r_f$ plus a "spread" $r_s$ ($r_b = r_f + r_s$). This extra spread is the extra yield that the market needs to be paid to purchase the corporate bond instead of buying an equivalent amount of risk-less bonds. In other ...

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Markit Pricing Data is a prime source for cds data (not free).

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For an individual firm, a theoretical model of the capital structure was developed by Robert Merton in 1974. The simplest form of this model assumes the firm has zero-coupon debt maturing at some future time $T$. Default is defined as the condition where the value of the firm's assets fall below the outstanding debt. The firm equity is viewed as a call ...

5

I could not find any such detailed documentation after some weeks of looking (not non-stop obviously). It is appallingly documented. I do understand fully what it does though so am happy to field some questions on it if you like. In a nutshell, I can tell you it is a standard reduced-form credit model under a constant hazard rate (i.e. homogeneous Poisson ...

4

One could say that a CDS price is determined by the physical default probability and the risk premium. The physical PD (PPD) is the actual probability of company defaulting within the given period of time. It is purely a theoretical concept as no one really knows what this probability is. We could estimate it using some models or credit ratings, but those ...

4

there is no standard approach to model quanto CDS. In practice, people look at the dynamic hedging costs over time as well as the expected loss from an fx gap in the event of a default of the ref entity. the former is modelled by some correlated brownian (for FX) and mean-reverting processes (for credit - could be Ornstein Uhlenbeck for example). In addition,...

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The chapter in Hull on Credit Risk gives the same formula as emcor as a first approximation with a justification: Consider first an approximate calculation. Suppose that a bond yields 200 basis points more than a similar risk-free bond and that the expected recovery rate in the event of a default is 40%. The holder of a corporate bond must be expecting ...

3

well you can use CDS spreads to strip out implied default probabilities for default before time $T.$ These had better be increasing as a function of $T$ or you have an arbitrage opportunity. However, there is an assumption here that there is no default risk on the CDS swap itself once you take that into account there may be a good chance of profit but no ...

3

Here is a link to a very interesting paper about the subject. The model assumes lognormal intensities (I think to ensure non-arbitrage as default probability must always be between 0 and 1, which is not the case if we assume Gaussian process for the intensity) deterministic FX volatility correlation between FX and the intensity a jump in the FX spot in the ...

3

I urge you to not compare CDS contracts and pairs with cash equity pair trades. The profiles are entirely different. CDS pairs are much more similar to being long and short an options contract. As protection buyer you are essentially long an option, you pay an "insurance premium" and that is what you are standing to lose at maximum. However, as protection ...

3

Your transition matrix $M$ has a time horizon associated with it, typically one year but sometimes 3 months or 5 years. Assume for convenience the horizon is 3 months. If it is not, you may wish to take a matrix square root to turn it into a 3 month matrix. Now the 6 month transition probabilities are formed by multiplying the matrix with itself, $M \... 3 The basic idea behind the CDS to provide protection from credit risk to the buyers of corporate bond. They are supposed to be like a insurance product where he buyer of the CDS pay the premium to the seller for the repayment of principle amount if company gets defaulted. But CDS are different from insurance product in two ways. As pointed by Stulz (2010) ... 2 You should use the ratings-based default probabilities to derive the "fair" spreads on a set of hypothetical new contracts and compare this result to the market spreads. Each could then be used independently to also derive the price for an existing CDS. There is no set way to combine the two prices, as these are two completely different and independent ... 2 Well I m affraid that there is a little bit of confusion here. Ratings are ... Ratings usually when used by notation agencies they imply a definite fixed once for all default probability (or transition matrix to some other rating) and then issuers are classified among those ratings usually by using some historical data. When using CDS spread then you get ... 2 Here is another Credit Default Swap database which is rather extensive, daily spreads of roughly 700 entities starting in 2006. 2 Markit is a pretty good source for CDS information, and their prices are pretty much the standard the industry goes by. Your best bet for finding large spreads would be to look at some of the European Banks or possibly TEPCO after the Japan Tsunami. Derivatives by default aren't "standard," the instruments are designed to be flexible, but the closest ... 2 The consensus seems to be is using jump diffusion process (affine), and then using copula's and/or correlated brownian motions to handle the correlation structure. Here's a link to a recent paper that discusses these models in great detail, and includes application of these models for modeling quanto cds: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=... 2 A friend gave me the following reply in terms of dynamic hedging and portfolio management: Quantitative justification Pricing models for a CB are based on holding the CB hedged with a short equity position. The combined portfolio has zero delta. However, it has positive gamma. To see this, consider that delta increases when the probability of conversion ... 2 An implied correlation$\rho_i(k_1,k_2)$is a correlation that matches the$(k_1,k_2)$tranche price$P_{k_1}^{k_2}$(usually computed under a gaussian or student t copula) $$C(k_1,k_2,\rho_i(k_1,k_2)) = P_{k_1}^{k_2}$$ For mezzanine tranches, there can sometimes be two different implied correlations matching the tranche price. A base correlation$b_i(...

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Most, but far from all, companies maintain a relatively steady debt load. When a bond matures, they fund its principal payout with a new bond. Sometimes companies do take on more and more debt, meaning that CDS protection sold during earlier times of small debt loads becomes more valuable (and underpriced, from the point of view of the protection seller). ...

2

The relationship between volatility and CDS is very interesting. Volatility in finance is synonym of risk. There are many aspects of volatility. There are 2 primary ways to find CDS premium, one is using structural model and the other is reduced form or intensity based model. Structural models use equity valuation, outstanding debt and equity volatility to ...

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It depends on how one is thinking about the hedge. One might be thinking of it as A hedge against catastrophic risk (default of the issuer), or A hedge against changes in (market-implied) default intensity or hazard rate In the former case, which seems to be how you are considering it, the hedge is a static hedge, kept for up to 5 years, and insulates ...

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Risk-neutral default probability implied from CDS is approximately P=1-e^(-S * t/ (1-R)), where S is the flat CDS spread and R is the recovery rate. The CDS Spread can be solved using the inverse; S=ln(1-P)*(R-1)/t. S=spread expressed in percentage terms (not basis points) t=years to maturity R=recovery rate in percentage terms Hulls equation is a gross ...

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From http://www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000183612.pdf: $$p_{def}=\frac{CDS_{spread}}{1-Rec}$$ $$\Leftrightarrow CDS_{spread}=p_{def}(1-Rec)$$ where $Rec$ is the recovery rate in case of default.

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When you long a 5y CDS and the spreads <5y increase and the 5y spread remains constant, the premium leg value is decreased. It appears that the CDS value should increase, and you should have a positive sensitivity. However, depending on the shape of the survival probability curve, the protection leg value may also decreased, and then the CDS value, which ...

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Better than Markit, you can have a look at https://www.datagrapple.com/ (subscription is free). About 1000 CDS are covered. Daily end-of-day prices (mid of a best bid/offer order book) from Jan 2006 and continues on an ongoing basis. There are the charts you want starting 2006. I think you may also be able to subscribe to an intra-day livefeed if you want.

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The choice of normalization depends on your data set: Without normalization : variable with high variance will have more impact on the PCA. You will have size effects. For exemple if you have one variable in meters and the other one in kilometers the one in meters will have way more impact. To avoid that you can normalize but now every variable will have ...

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Well, you should use the spread as the default probability. For example, A CDS spread of 593 bp for five-year Brazilian debt means that default insurance for a notion al amount of USD 1 m costs USD 59,300 p.a. Consider a 1-year CDS contract and assume that the total premium is paid up front. Let S: CDS spread (premium), p: default probability, R: recovery ...

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In many years working in the credit markets, I never encountered anyone making an approximation of CDS spread being equal to risky par bond yield. If we approximate CDS coupon payments as a continuous stream $s$, default intensity as a constant $h$, and we assume that discount factors come from a constant risk-free rate $r$, then the CDS pricing formula ...

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RRL's answer is entirely correct in terms of the theoretical reason underpinning the relationship between equity IV and CDS spreads. "CDS spreads are not “pure” default risk compensation" - no they are not since the ISDA Quoted Spreads assume a homogeneous Poisson process (implying that instantaneous default risk is a constant over the life of a contract) ...

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