Quantitative Finance Stack Exchange is a question and answer site for finance professionals and academics. It only takes a minute to sign up.
Sign up to join this community
I am trying to understand if the conventional spread column in Markit's CDS database simply represents the CDS spread, measured in bps, or should I make some adjustments (in case I would like to make some comparisons between CDS's with different coupns, e.g., 1% or 5%)?
Thank you!
The CDS spread is quoted in basis points. It represents the fraction of the face value that the credit protection buyer would pay every year to the protection seller. For example "75" basis points for 5Y tenor means that to buy protection on USD 10,000,000 face value, you'd need to pay 0.0075 $\times$ USD 10000000 = USD 75,000 a year for 5 years. There would be zero upfront fee because the swap would have zero msrk to market. This us how CDSs used to be traded before the "big bang".
But this is just a quoting convention. Following the "big bang", what actually gets traded is a "standard" contract, with standardized running spreads. So in this example, the protection seller would actually pay some upfront fee to the buyer (because quoted < standard 100), and then the buyer would pay 25 bps every 3 months. The conversion from the quoted CDS spread, combined with a recovery assumption that it's tagged with and an interest rate curve (which affects the result little) to risk neutral default probability curve using JPM's standard CDS model is unambiguous. Further conversion from the risk neutral default probability curve combined with a standard running spread (usually 100 bps, sometimes 500 bps, or some other) to the upfront fee that actually gets paid at inception is also unambiguous.
Some names on the verge of default are already quoted as upfront in percent. E.g. 40% upfront means the buyer pays 30% of the notional upfront and then 5% of the notional every year. The upfront depends on the running spread.
So if you're comparing quoted CDS spreads to each other, then you don't need to know whether they're for 100 or 500 bps running spread; but if you're converting a not-too-high upfront fee into a spread fir comparison purposes, then you do need the running spread.
