The importance of adequately modeling credit risk has once again been highlighted in the recent financial crisis. Defaults tend to cluster around times of economic stress due to poor macro-economic conditions, but also by directly triggering each other through contagion. Although credit default swaps have radically altered the dynamics of contagion for more than a decade, models quantifying the...

This paper provides a methodology for valuing credit default swaps (CDS). In these financial instruments a sequence of payments is promised in return for protection against the credit losses in the event of default. Given the widespread use of credit default swaps, one major concern is whether the credit risk has been priced accurately. Credit risk assessment of counterparty is an area of renew...

We show whether central clearing of a particular class of derivatives lowers counterparty risk. For plausible cases, adding a central clearing counterparty (CCP) for a class of derivatives such as credit default swaps reduces netting efficiency, leading to an increase in average exposure to counterparty default. Further, clearing different classes of derivatives in separate CCPs always increase...

This paper explores trading strategies to identify possible imbalances that may have been existed in the credit markets, during the period 2001–2006, when pairing CDS and CMCDS on the same name. To this end, a large database of single-name CDS premia is used to produce the corresponding CMCDS prices, derived by implementing common market models. It appears that, in general, it would have been m...

We propose a general setting for pricing single-name knock-out credit derivatives. Examples include Credit Default Swaps (CDS), European and Bermudan CDS options. The default of the underlying reference entity is modeled within a doubly stochastic framework where the default intensity follows a CIR++ process. We estimate the model parameters through a combination of a cross sectional calibratio...

The pricing problem of credit derivatives has received much attention in the last decade. An important unresolved problem, however, is the pricing of credit derivatives under the general environment in which the interest rate process and the hazard rate process are stochastic. This article addresses the pricing problems of credit derivatives (defaultable bonds, default swaps, and default option...

We propose a general framework for estimating the vulnerability to default by a central counterparty (CCP) in derivatives markets. Unlike conventional stress testing approaches, which estimate the ability of a CCP to withstand nonpayment by its two largest counterparties, we study the direct and indirect effects of nonpayment by members and/or their clients through the full network of exposures...