Abstract
Portfolio default swaps (PDSs) are similar to basket swaps (Chapter 9) in that they transfer portions of the credit risk associated with a portfolio from a protection buyer to a protection seller. A key difference is that the risk transfer is specified in relation to the size of the default-related loss in the reference portfolio instead of in terms of the number of individual defaults among the reference entities. For instance, whereas protection sellers in a first-to-default basket are exposed to the first default in the reference basket, protection sellers in a “first-loss” PDS are exposed to default-related losses that amount up to a prespecified share of the reference portfolio.
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