The Pricing of Credit Default Swaps During Distress

 
Author/Editor: Andritzky, Jochen R. ; Singh, Manmohan
 
Publication Date: November 01, 2006
 
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
 
Summary: Credit default swaps (CDS) provide the buyer with insurance against certain types of credit events by entitling him to exchange any of the bonds permitted as deliverable against their par value. Unlike bonds, whose risk spreads are assumed to be the product of default risk and loss rate, CDS are par instruments, and their spreads reflect the partial recovery of the delivered bond's face value. This paper addresses the implications of the difference between bond and CDS spreads and shows the extent to which the recovery assumption matters for determining CDS spreads. A no-arbitrage argument is applied to extract recovery rates from CDS and bond markets, using data from Brazil's distress in 2002-03. Results are related to the observation that preemptive restructurings are now more common than straight defaults in sovereign bond markets and that this leads to a decoupling of CDS and bond spreads.
 
Series: Working Paper No. 06/254
Subject(s): Credit risk | Brazil | Risk premium | Bond markets | Prices

Author's Keyword(s): Credit default swaps | Brazil | recovery value | default risk
 
English
Publication Date: November 01, 2006
ISBN/ISSN: 1934-7073 Format: Paper
Stock No: WPIEA2006254 Pages: 23
Price:
US$18.00 (Academic Rate:
US$18.00 )
 
 
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