Anticipating Credit Events Using Credit Default Swaps, with an Application to Sovereign Debt Crises

DefaultRisk.com the web's biggest credit risk modeling resource.

Submit Your Paper

Post Your Résumé

For Recruiters

Today's Featured Book

A Guide To Active Credit Portfolio Management
by Risk Books, August 31, 2008, Hardcover, 200 pages

Training Discounted for DefaultRisk.com visitors only:

The Mathematics of Credit Derivatives: The Essential Credit Modelling and Pricing Companion
by Philipp J. Schönbucher,
WBS Training, August 2003, DVD / Interactive CD-ROM

Sponsor:
Shop at Amazon.com and support DefaultRisk.com

Anticipating Credit Events Using Credit Default Swaps, with an Application to Sovereign Debt Crises

by Jorge A. Chan-Lau of the International Monetary Fund

May 2003

Abstract: In reduced-form pricing models, it is usual to assume a fixed recovery rate to obtain the probability of default from credit default swap prices. An alternative credit risk measure is proposed here: the maximum recovery rate compatible with observed prices. The analysis of the recent debt crisis in Argentina using this methodology shows that the correlation between the maximum recovery rate and implied default probabilities turns negative in advance of the credit event realization. This empirical finding suggests that the maximum recovery rate can be used for constructing early warning indicators of financial distress.

JEL Classification: G0, G15.

Keywords: Credit default swaps, maximum recovery rate, default probability, sovereign risk.

Books Referenced in this Paper: (what is this?)