Credit Default Swaps Pricing And Risk

Credit default swaps as a mainstream product of credit derivatives, play the role of risk avoidance. In this paper, based on the principles of the reduced-form models and the mortgage market, there is a CDS trading process by computer simulation on simplified conditions. By changing the simulation parameters, one thing can be confirmed- the main factors affecting the CDS pricing are the default rates and the recovery rates. Meanwhile, the reasons of sub-prime CDS pricing deviation are shown-the overestimated recovery rates and the underestimated default rates, owing to over optimistic about the economy. So ultimately the protect seller can not undertake the huge reparation. Then the risks of credit default swaps are analyzed. As a risk management tool, CDS can indeed play a certain role of the credit risk transfer, but also has its own risk, such as pricing risk, partner risk, or liquidity risk. In a word, Credit derivatives just can only transfer the risk, not eliminate it.Considering the relationship of the CDS mispricing and the sub-prime crisis, an evolutionary game theory is used in the last part of the paper. This part analyzes the behavior of the banks and the lender, and it also discusses the process of the dynamic evolution and the stable equilibrium strategy under two different economic environments. At last, it expounds an important cause of the subprime crisis based on the evolutionary game theory.