Mastering Credit Derivatives: A step-by-step guide to credit derivatives and structured credit, Second Edition

Chapter 3. Pricing a CDS and the cash bond basis

Credit Modelling

To price and manage the risk of credit derivatives, a framework is needed for valuing credit risk to a single issuer and to many issuers. The growth of the credit derivatives market has created a need for more powerful models and for a better understanding of the empirical evidence needed to calibrate these models. This section presents an overview of modelling approaches from a practical perspective, in terms of models, implementation and calibration.

Single credit modelling

Credit modelling uses two main approaches: structural and reduced form. In the structural approach, the default is characterized as the consequence of some event such as a company’s asset value being insufficient ...