The Art of Credit Derivatives: Demystifying the Black Swan

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Introduction

If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand.

Milton Friedman

 

 

The credit derivatives market surged from USD 200 billion in 1997 to an astonishing USD 55 trillion in 2008. The largest growth happened in 2006 and 2007. When associated with the securitization process, the CDS asset class was in the driving seat of the enormous economic and consumption expansion that took place in the world economy in the post-internet bubble years.

A proper and detailed introduction to credit derivatives can be found in many books already on the market. For an overview of the credit derivatives market, the available instruments, their valuation and trading strategies we refer to the JP Morgan Credit Derivatives Handbook (JP Morgan, 2006) and to the Morgan Stanley Structured Credit Insights books (Morgan Stanley, 2007a; 2007b). For an introduction to stochastic calculus for finance we refer to Shreve (2004a; 2004b), and to Bingham and Kiesel (2004). For an introduction to credit risk modeling we refer to Bluhm et al. (2003). We refer to Schönbucher (2003) and O’Kane (2008) for credit derivatives pricing. A classic work on options, futures and other derivatives is the book by Hull (2003). For an overview of the bond market we refer to Fabozzi (2004).

This book complements the above references in many respects. First, we focus on the standardized credit indices. Second, we try not to focus only on the instrument and the ...