Pricing Credit Default Swaps with Option-Implied Volatility
Posted: 9 Aug 2011 Last revised: 11 Sep 2011
Date Written: August 9, 2011
Using the industry benchmark CreditGrades model to analyze credit default swap (CDS) spreads across a large number of companies during the 2007-09 credit crisis, the authors demonstrate that the performance of the model can be significantly improved by calibrating it with option-implied volatility rather than with historical volatility. Moreover, the advantage of using option-implied volatility is greater among companies with more volatile CDS spreads, more actively traded options, and lower credit ratings.
Keywords: Derivatives, Credit Derivatives Markets and Instruments, Modeling and Pricing Credit Derivatives, Options Markets and Instruments, Volatility Issues
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