Chapter 7

The Asset Swap–Credit Default Swap Basis1

We saw in Chapter 2 that asset swaps, although pre-dating the credit derivative market, are a form of credit derivative but are in fact viewed as cash market instruments. However, because an asset swap is a structure that expllicitly prices a credit-risky bond in terms of its spread over Libor (inter-bank credit risk), in theory it can be viewed as a means by which to price credit derivatives. In fact, in the early days of the credit derivatives market the most common method of pricing credit default swaps (CDSs) was by recourse to the asset swap spread of the reference credit, as the CDS premium should (in theory) be equal to the asset swap spread of the reference asset. Certainly we can say ...

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