Chapter 6

Credit Default Swap Pricing

We concentrate specifically now on the credit default swap (CDS), and a market approach for pricing these instruments. We consider here the plain vanilla structure, in which a protection buyer pays a regular premium to a protection seller, up to the maturity date of the CDS, unless a credit event triggers termination of the CDS and a contingent payment from the protection seller to the protection buyer. If such a triggering event occurs, the protection buyer only pays a remaining fee for accrued protection from the last premium payment up to the time of the credit event. The settlement of the CDS then follows a pre-specified procedure, which was discussed in Chapter 2.

6.1 Theoretical Pricing Approach

A default ...

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