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Credit Switch

by Karan Bhanot of the University of Texas

July 31, 2001

Abstract:  A credit switch is the simultaneous purchase of credit protection on one asset and the sale of credit protection on another asset. This article provides a model for valuing this credit derivative whose payoff depends on the identities of a given list of credit events, such as defaults. The survival probabilities are modeled as a stochastic intensity process under a risk neutral framework. Closed form solutions are provided when the intensity process follows a popular diffusion process. A numerical example illustrates the effectiveness of a credit switch as a corporate risk- management solution.

JEL Classification: G13, G33.

Keywords: Credit Risk, Credit Derivatives, Risk Management.

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