Chapter 8

Options on Credit Default Swaps and Credit Default Indexes

Marek Rutkowski

School of Mathematics and Statistics, University of Sydney

We focus on derivations of valuation formulas and hedging strategies for credit default swaptions and credit default index swaptions. Most results presented in this chapter are independent of a particular convention regarding the specification of fee and protection legs, so that they can also be applied to valuation of other credit derivatives that exhibit similar features as credit default swaptions, for instance, options on CDO tranches. The main tool is a judicious choice of the reference filtration combined with a suitable specification of the risk-neutral dynamics for the predefault (loss-adjusted) ...

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