Swap Rates and Credit Quality: Supplementary Results
by Darrell Duffie of Stanford University, and
March 31, 1995
Abstract: The impact of credit quality on swap rates is determined under alternative netting assumptions. With counterparties of different default risk, swap valuation is non-linear in the underlying promised exchange of cash flows. The impact of credit risk asymmetry and of netting is presented through both theory and numerical examples, which include interest rate and currency swaps.
The above working paper is available for download, but please note that it was published in slightly modified form as follows:
Duffie, Darrell and Ming Huang, "Swap Rates and Credit Quality", Journal of Finance, Vol. LI, No. 2, (July 1996), pp. 921-949.
Abstract: This article presents a model for valuing claims subject to default by both contracting parties, such as swaps and forwards. With counterparties of different default risk, the promised cash flows of a swap are discounted by a switching discount rate that, at any given state and time, is equal to the discount rate of the counterparty for whom the swap is currently out of the money (that is, a liability). The impact of credit-risk asymmetry and of netting is presented through both theory and numerical examples, which include interest rate and currency swaps.