Credit Default Swap Pricing Research

Credit default swap(CDS) is a relatively simple structure of credit derivatives, which are widely used in credit risk management. The main research purpose of this article is the pricing theory of CDS and the application of its pricing model in Chinese credit derivatives market.This article made a simple introduction about the structure and function of CDS. Before the research of pricing theory, it is important to familiar with the CDS contracts design, product features and functions, and to understand the effects of credit default swaps on market behavior.According to the different assumptions of corporate default process, we concluded two kinds of pricing model:(1) Structural Credit Models, which assumes that the company’s default is endogenous.(2) Reduced Form Credit Models, which assumes that the company’s default is a special events or shock which is exogenous. Meanwhile, we analyzed the merits of the two models.According to the development of Chinese credit market conditions, we have selected the reduced form credit models as the pricing model of CDS using in Chinese bond market. Using the theoretical basis of reduced form credit models, we improved the model to solve the problem of shortage of Chinese bond market experience data.We select the medium-term notes traded in the inter-bank market as underlying bonds, and these bonds’ credit rating are AAA, AA +, AA, AA – separately. And we priced each term of CDS spreads of the medium-term notes. The results show that the pricing of CDS spreads of the medium-term notes are relatively reasonable. Meanwhile, using the pricing model, according to the volatility of CDS spreads of the medium-term notes, we concluded the impact of the default of "Super Sun Bonds" to Chinese bond market. Except the month when the default happened, the CDS spreads were basically stable. The results show that the investors have expectation for bond defaults.