Credit default swap valuation: an application via stochastic intensity models

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2016

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Namuslu, Merve

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The objective of this thesis is to study the pricing of a single-name credit default swap (CDS) contract via the discounted cash flow method with reduced-form survival probability functions depending on stochastic intensity. The ability of the model in predicting the market-observed spreads is tested as well by using bond and CDS data from the US market. In credit risk modeling, the CIR (Cox-Ingersoll-Ross) model is used. The main reason for using a reduced-form model in pricing the CDS contracts is the advantages of such models in terms of being more flexible, practical and tractable. In model calibration, each sample firm’s bond price is used while determining the optimal set of parameters for the CIR default intensity process. For this purpose, the firm’s stochastic default probabilities are estimated within the least squares framework. Data on two of the Dow Jones 30 Index constituents, the Coca-Cola Company and JPMorgan Chase, are used in the analyses. The term structure of daily bond prices that are used to estimate the hazard rate parameters and the daily prices of the firms’ CDS contracts that are used to test the success of the model are obtained from Thomson Reuters. The model’s success is tested over two distinct time periods. The first period is from July 2008 to September 2008 (pre-crisis) and the second period is from January 2016 to March 2016 (post-crisis). The proxy for the risk-free interest rate is the federal funds rates.

Subject Keywords

Credit analysis., Swaps (Finance)., Credit

URI

http://etd.lib.metu.edu.tr/upload/12620208/index.pdf
https://hdl.handle.net/11511/25834

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Graduate School of Applied Mathematics, Thesis

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Citation Formats

M. Namuslu, “Credit default swap valuation: an application via stochastic intensity models,” M.S. - Master of Science, Middle East Technical University, 2016.