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.
Keywords: Credit Risk, Credit Derivatives, Risk Management.