Chapter 5

Credit Derivatives Pricing and Valuation

In this chapter we look at the various approaches used in pricing and valuation of credit derivatives. We consider generic techniques and compare prices obtained using different pricing models. We also present a first-principles method of pricing credit default swaps based on the original pricing approach articulated by Professor Darrell Duffie in 1992.

5.1 Introduction

The pricing of credit derivatives should aim to provide a ‘fair value’ for the credit derivative instrument. In the sections below we discuss the pricing models currently used in the industry. The effective use of pricing models requires an understanding of the models’ assumptions and the key pricing parameters, and a clear understanding ...

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