Principles of Financial Engineering, 2nd Edition

CHAPTER 16

Credit Markets: CDS Engineering

1. Introduction

Credit derivatives have had a revolutionary effect on financial engineering. This is true in (at least) two respects. First, liquid credit derivatives permit stripping, pricing, and trading the last major component in financial instruments, namely the credit risk. With credit derivatives, synthetics for almost any instrument can be built.¹ Second, and as important, is the special role played by credit quants and financial engineers. Major broker-dealers started organizing the credit market after the development of major instruments such as options, swaps, constant maturity swaps, and swaptions was complete. New knowledge and skills were already in place. Credit markets were developed ...