APPENDIX III
Market-Implied Timing of Default from CDS Prices
The premium payable on a credit default swap (CDS) contract is an explicit valuation of default risk.1 Given that the CDS has a specified fixed term to maturity, it is possible by applying break-even analysis to extract a market-implied timing of default for the reference credit in question. This is done by calculating the amount of time that has to elapse before the premium income on the CDS equals the recovery value. By definition therefore, we require an assumed recovery rate to perform this calculation.
When a credit reference shows signs of distress, the CDS market begins to reflect this by marking higher the price of a CDS written on that name. This implies the timing of the ...
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