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The Valuation of Default-Triggered Credit Derivatives

Published online by Cambridge University Press:  06 April 2009

Ren-Raw Chen  and
Ben J. Sopranzetti
Ren-Raw Chen
Affiliation:
[email protected], Department of Finance and Economics, School of Business, Rutgers University, 94 Rockafeller Road, Piscataway, NJ 08854
Ben J. Sopranzetti
Affiliation:
[email protected], Department of Finance and Economics, School of Business, Rutgers University, 94 Rockafeller Road, Piscataway, NJ 08854.
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Abstract

Credit derivatives are among the fastest growing contracts in the derivatives market. We present a simple, easily implementable model to study the pricing and hedging of two widely traded default-triggered claims: default swaps and default baskets. In particular, we demonstrate how default correlation (the correlation between two default processes) impacts the prices of these claims. When we extend our model to continuous time, we find that, once default correlation has been taken into consideration, the spread dynamics have very little explanatory power.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 2 , June 2003 , pp. 359 - 382
Copyright
Copyright © School of Business Administration, University of Washington 2003

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