If I know all the economics of a CDS trade included the Upfront Settlement Fee from the ISDA CDS Model, how can I convert that amount back to Traded Spead? Can some help explain the process?
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3$\begingroup$ This is all explained on the official website: cdsmodel.com/cdsmodel/documentation.html?# under "Standard CDS contract converter specification" $\endgroup$– QuantupleCommented Feb 9, 2017 at 8:34
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$\begingroup$ Your question is not clear. What is the Traded Spread? Do you want to convert the upfront fee into a par spread that leads to a zero CDS value, or a spread so that the CDS value is equal to the upfront fee? $\endgroup$– GordonCommented Feb 9, 2017 at 14:31
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$\begingroup$ Here is real example of what I am looking to achieve. Lets say I only know the following information: Trade Date: 2/9/17 Maturity Date: 12/20/21 Notional: 10mm Fixed Coupon:500bps Upfront Fee: $270,324 and assuming 40% recovery, how could I determine the Traded Spread from this information? I believe we are saying Traded Spread and Par Spread are the same. $\endgroup$– Chris NCommented Feb 9, 2017 at 15:29
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$\begingroup$ Are you trying to find out the traded (par) spread on 2/9/17 or today? If the answer is today, you need to access CDS market data to construct a spread curve. Markit is the standard here. $\endgroup$– Bond wizCommented Dec 14, 2019 at 22:20
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2 Answers
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You should check this answer: How to interpret the 'price' of a CDS?
It explains the relation between spread and upfront. In your particular case you might consider using a simple model mentioned at the end of that answer:
A simple model for the value of a short protection CDS can be found if you write
V = (C-S) x RPV01
where
RPV01 = (1−exp(−gT))/g
and C is the coupon, S is the par CDS spread, T is the remaining life in years and
g=r+S/(1−R)g=r+S/(1−R)
where r is the risk-free (Libor) rate and R is the expected recovery rate, usually set to 40%.
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$\begingroup$ Thank you this information. The issue that I am finding with this equation is that I am trying to solve for S (CDS Spread) and when finding the value for RPV01 the CDS Spread is embedded in the calculation ( by solving for "g"). What is the Libor value here or how would I solve for Libor? $\endgroup$– Chris NCommented Feb 11, 2017 at 4:35
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$\begingroup$ @ChrisN In your example maturity is in 5 years, so as a risk free rate you might use US treasury bond with 5y maturity. That's right, the equation i ls not directly solvable for S, so you might consider using a numerical method to find a solution for that equation $\endgroup$ Commented Feb 11, 2017 at 6:33
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Or, if you need a quick estimate, you could use $T$ as a rough approximation for the RPV01.
$$ s \approx c - V/T $$
