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On the lognormality of forward credit default swap spreads

Author

Listed:
  • Jabbour, George

    (The George Washington University)

  • El Masri, Fatena

    (E-Trade)

  • Young, Stephen

    (Evergreen Investments)

Abstract

The market for credit default swaps continues to grow in terms of the number of underlying traded names and transactions as well as notional volumes outstanding. With the growth in credit default swaps it is natural to expect a market for options on credit default swaps to follow. Options on credit default swaps exist but are thinly traded via the over-the-counter market and the current modeling paradigm is based on the Black-Scholes framework. The underlying for an option on a credit default swap is the forward credit default swap spread for a particular reference entity. This paper examines the statistical properties of forward default swap spreads and strongly rejects the hypothesis that they are lognormally distributed. Furthermore, the analysis in this paper rules out credit migrations as the sole cause for the significant deviation from normality.

Suggested Citation

  • Jabbour, George & El Masri, Fatena & Young, Stephen, 2008. "On the lognormality of forward credit default swap spreads," Journal of Financial Transformation, Capco Institute, vol. 22, pages 41-48.
    • Handle: RePEc:ris:jofitr:0870
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    Citations

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    Cited by:

    1. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2011, January-A.
    2. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 5, July-Dece.

    More about this item

    Keywords

    Credit derivatives; credit risk; credit default swaps; options on credit default swaps; credit default swaptions;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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