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Combining hazard rates with the CreditGrades model: A hybrid method to value CDS contracts

Author

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  • Chih-Wei Lee

    (Department of Finance, National Taipei University of Business, No. 321, Chi-Nan Rd., Sec. 1, Taipei, Taiwan, R.O.C.)

  • Cheng-Kun Kuo

    (Department of International Business, College of Management, National Taiwan University, No. 85, Roosevelt Rd., Sec. 4, Taipei, Taiwan, R. O. C.)

Abstract

In this paper, we propose a hybrid method that combines a hazard rate model with the CreditGrades model to value credit default swap (CDS) contracts. The CreditGrades model is considered an industry benchmark for analyzing credit derivatives. The hybrid method makes use of the default probability generated by the CreditGrades model to determine the hazard rate specific to the bond issuing firm. In this way, the hybrid method is empirically shown to produce better CDS forecast.

Suggested Citation

  • Chih-Wei Lee & Cheng-Kun Kuo, 2015. "Combining hazard rates with the CreditGrades model: A hybrid method to value CDS contracts," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 2(04), pages 1-14, December.
    • Handle: RePEc:wsi:ijfexx:v:02:y:2015:i:04:n:s2424786315500371
    DOI: 10.1142/S2424786315500371
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    References listed on IDEAS

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