The Pricing of Credit Default Swaps During Distress

Author/Editor:

Manmohan Singh ; Jochen R. Andritzky

Publication Date:

November 1, 2006

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

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. 2006/254

Subject:

Bonds Credit Credit default swap Securities markets Yield curve

English

Publication Date:

November 1, 2006

ISBN/ISSN:

9781451865141/1018-5941

Stock No:

WPIEA2006254

Pages:

23

Please address any questions about this title to publications@imf.org