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In Rememberance: World Trade Center (WTC)

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An Empirical Study of Credit Default Swaps

by Frank Skinner of the University of Reading, and
Antonio Díaz of the Universidad de Castilla - la Mancha

January 2003

Abstract: We examine the pricing of Asian and non-Asian credit default swaps that traded during the 1997 to 1999 time period. We employ two credit risk models, Duffie and Singleton (1999) and Jarrow and Turnbull (1995). We argue that credit default swaps should have a positive economic value since credit spreads reflect differences in liquidity as well as credit risk. However, in the presence of moral hazard we expect to see negative economic value since asymmetric information would motivate sellers of credit default swaps to demand a "restructuring premium". While we generally find positive economic values for credit default swaps, both models find negative economic values for Asian credit default swaps during the recent Asian currency crisis, which we attribute to moral hazard.

JEL Classification: G13, G22, G24.

Keywords: Credit default swaps, moral hazard, recovery rates, asymmetric information.

Published in: Journal of Fixed Income, Vol. 13, No. 1, (June 2003), pp. 28-38.

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