I'm trying to estimate CVA of one of my derivatives by valuing a credit default swap (CDS) of my counterparty. However, I don't know how to set up the CDS deal (notional amount, maturity, etc.).


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    $\begingroup$ "I don't know how to set up the CDS deal " what do you mean by this. Setup where. I suggest you read somliterature on this. Spreads can give estimate of def. prob but you need to know recovery rate, the undelying derivatives Cashflows (for expected Exposure). $\endgroup$ – ash Nov 26 '14 at 9:10

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 rate. The protection buyer expects to pay: S. His expected pay-off is (1-R)p. When two parties enter a CDS trade, S is set so that the value of the swap transaction is zero, i.e. S=(1-R)p ↔ S/(1-R)=p.

If R=25%, a spread of 500 bptranslates into p =6.6%. If R=0, we have S=p=5%.

I found this wikipedia article very enlightening. Price and Valuation

  • $\begingroup$ Will I use cds spread as default probability? Or I need to bootstrap it $\endgroup$ – Carlos F. Nov 27 '14 at 2:43
  • $\begingroup$ You use ir as a Credit Spread for the spread zero curve. Imagine you have a Corp Bond, then the credit spread over the bond would be very similar to the CDS for the same Corporation. Im posting a link that i hope helps ou clarify what you should be aware of. $\endgroup$ – MattR Nov 28 '14 at 13:34

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