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The Valuation of Default-Triggered Credit Derivatives

by Ren-Raw Chen of Rutgers University, and
Ben J. Sopranzetti of Rutgers University

April 22, 2002

Abstract:  Credit derivatives are among the fastest growing contracts in the derivatives market. We present a simple, easily implementable model to study the pricing and hedging of two widely traded default-triggered claims: default swaps and default baskets. In particular, we demonstrate how default correlation (the correlation between two default processes) impacts the prices of these claims. When we extend our model to continuous time, we find that, once default correlation has been taken into consideration, the spread dynamics have very little explanatory power.

Published in: Journal of Financial and Quantitative Analysis, Vol. 38, No. 2, (June 2003), pp. 359-382.

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