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The Valuation of Credit Default Swap with Counterparty Risk and Collateralization

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  • Xiao, Tim

Abstract

This article presents a new model for valuing a credit default swap (CDS) contract that is affected by multiple credit risks of the buyer, seller and reference entity. We show that default dependency has a significant impact on asset pricing. In fact, correlated default risk is one of the most pervasive threats in financial markets. We also show that a fully collateralized CDS is not equivalent to a risk-free one. In other words, full collateralization cannot eliminate counterparty risk completely in the CDS market.

Suggested Citation

  • Xiao, Tim, 2019. "The Valuation of Credit Default Swap with Counterparty Risk and Collateralization," FrenXiv 6m73z, Center for Open Science.
    • Handle: RePEc:osf:frenxi:6m73z
    DOI: 10.31219/osf.io/6m73z
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    1. Michael Johannes & Suresh Sundaresan, 2007. "The Impact of Collateralization on Swap Rates," Journal of Finance, American Finance Association, vol. 62(1), pages 383-410, February.
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