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A Unified Approach to Credit Default Swaption and Constant Maturity Credit Default Swap Valuation

by Martin Krekel of HypoVereinsbank, and
Jorg Wenzel of Fraunhofer ITWM

October 12, 2006

Abstract: In this paper we examine the pricing of arbitrary credit derivatives with the Libor Market Model with Default Risk. We show, how to setup the Monte Carlo-Simulation efficiently and investigate the accuracy of closed-form solutions for Credit Default Swaps, Credit Default Swaptions and Constant Maturity Credit Default Swaps. In addition we derive a new closed-form solution for Credit Default Swaptions which allows for time-dependent volatility and arbitrary correlation structure of default intensities.

JEL Classification: C31, G32.

Keywords: LIBOR market model, credit risk, Credit Default Swaption, Constant Maturity Credit Default Swap.

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