In this paper we compare market prices of credit default swaps with model prices. We show that a simple reduced form model with a constant recovery rate outperforms the market practice of directly comparing bonds' credit spreads to default swap premiums. We find that the model works well for investment grade credit default swaps, but only if we use swap or repo rates as proxy for default-free interest rates. This indicates that the government curve is no longer seen as the reference default-free curve. We also show that the model is insensitive to the value of the assumed recovery rate

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Econometric Institute Research Papers
Erasmus School of Economics

Houweling, P., & Vorst, T. (2003). Pricing default swaps: empirical evidence (No. EI 2003-51). Econometric Institute Research Papers. Retrieved from