# Tag Info

15

Risk-neutral default probability implied from CDS is approximately $P=1-e^\frac{-S * t}{1-R}$, where $S$ is the flat CDS spread and $R$ is the recovery rate. The CDS Spread can be solved using the inverse: $$S=\ln(1-P) \frac{R-1}{t}$$ $S$ is the spread expressed in percentage terms (not basis points) $t$ are the years to maturity $R$ is the recovery rate ...

11

I believe the answer can be further improved for all those being directed here by google after 3 years. A common way to model the default probability is by the hazard rate. As @Bob correctly mentions, a traditional requirement is for it to satisfy (see Option Futures and Other Derivatives section 23.4 in which the author discusses also other more exact ...

11

The indices have different quoting conventions. The way that a CDS index is traded is that you pay a fixed amount per year for protection in case of default (100 bps for IG, 500 bps for HY) and therefore the contract does not have a zero present value (as it would have if you paid the par spread, like in a fixed for floating interest rate swap). The amount ...

10

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 ...

9

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 ...

9

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

8

Firstly, have a look at this TwoSigma article: What Sovereign CDS Spreads Potentially Tell Us about Currency Risk To elaborate, if a country in the Euro Zone (like Italy) defaults, then this will clearly have an effect on the EUR as a whole, i.e. the EUR will weaken. So if you are insuring against Italy defaulting you really don't want your insurance ...

7

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 ...

7

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 to ...

7

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.

7

You and the paper are both correct. Funding was not free before the GFC, but the funding cost of both positions then was almost equal, generating almost-zero basis. Since then, holding physical bonds has become relatively more expensive, because these tie up bank balance sheet, which has become a scarce resource since the GFC. Or at least a scarcer resource ...

6

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

A good reference for the valuation of a CDS index option is the paper by Massimo Morini and Damiano Brigo, where they discussed the Bloomberg CDS index option valuation, which is based on Black's formula given the forward par index spread vol, strike, and time to maturity. The issue with this formula is that the numeraire, the Index Defaultable Present ...

5

For CDS indices, a new series is created every 6 months (3/20 and 9/20). With each new series, the basket of reference entities will generally change, with some names replaced by others. Rolling is the act of closing the old contract and opening the new contract. The maturity of the CDS is typically much longer, with 5Y being the most commonly traded tenor. ...

5

So as per my comments, the answer is yes. It's all about which leg is dominant, the loss payment, or the premium, if any. If you're short risk (bought protection) vs paying premium, then if the premium leg exceeds the loss leg (you're out of the money/OTM), then you want rates to rise to reduce the premium liability. If you're in the money (paying less than ...

5

The European iTraxx indices trade 3, 5, 7 and 10-year maturities, and a new series is determined on the basis of liquidity every six months. For the total return index : The regular roll process from the off-the-run into the new on-the-run index is simple. At any one point only the most recently available index CDS return is included in any one index. The ...

5

You would need to provide more details for an accurate PnL attribution. However, here are some additional points to consider that might help. When you sold protection, you effectively became long the 5Yr synthetic debt of the reference entity at a credit spread of 190bps. I assume that the reference entity and the sovereign where the company is domiciled ...

5

If it is a single name CDS, the transaction leaves the bank short the credit spread of that bond vs a risk-free bond in the same currency. To go long the spread, the bank would i) buy the same CDS from another bank or ii) sell short the same bond, and get rid of general interest rate risk by going long a risk-free bond (or interest rate swap) of the same ...

5

A reference entity (the debtor that might have a credit event) does not have any currency denomination. A reference entity might have many outstanding debt instruments. Each instrument is denominated in some currency. You need to choose one debt instrument as the reference obligation for the CDS contract. You choose the currency in which the CDS contract ...

4

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 ...

4

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(... 4 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). ... 4 From this research from Deutsche Bank, : $$p_{def}=\frac{CDS_{spread}}{1-Rec}$$ $$\Leftrightarrow CDS_{spread}=p_{def}(1-Rec)$$ where$Rec\$ is the recovery rate in case of default.

4

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 you ...

4

CVA is a price. Just like any price, you compute its sensitivities (greeks) and then use financial products to bring them as close to zero as possible. It's not possible to derive a hedging strategy just by looking at the CVA figure, it's like asking what the hedging strategy of a product is if its price is USD 1M... You need the CVA greeks. The ...

4

To continue from uness' answer (edit: just seen the OP was very old, but will leave here anyway!) . The greeks will be every element of market risk to which the the CVA is sensitive. Writing in words for celerity: A CVA is a credit linked option on the underlying instrument. You are sensitive to the credit default- (specifically the swap obligation payment ...

4

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) ...

4

You will see a discussion of how to do this in O'Kane's book in section 11.7. It shows that you can adjust the forward CDS index spread in such a way that you can then use Black's swaption pricing formula set out in section 11.3.1. You will need to calculate a few extra terms to make these adjustments which are all set out. These will need you to extract ...

4

Regarding the terminology, there is no relation between CDS spread and bid/ask spread. The term spread in this sense refers to the related difference (spread) of the effective (credit risky) interest rate and the "risk free" rate (also see "credit spread").

4

There are a number of ways you might consider it: 1) As an investor (speculator) you may be required to post collateral that permits the holding of the position. What is your return relative to the invested collateral (and/or possibly expected collateral if the trade moves adversely) 2) This is one of the performance metrics measured in an investment bank. ...

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