Credit Derivatives

Abstract

Credit derivatives will lead to a revolution in banking. One is definitely true: the volume of the credit derivatives market has increased enormously (see, e.g., table 5.2) since credit derivatives have been first publicly introduced in 1992, at the International Swaps and Derivatives Association annual meeting in Paris, and the end of this tendency is not about to come. Much of the growth in the credit derivatives market has been aided by the growing use of the LIBOR swap curve as an interest rate benchmark As it represents the rate at which AA-rated commercial banks can borrow in the capital mar­kets, it reflects the credit quality of the banking sector and the cost at which they can hedge their credit risks. It is, therefore, a pricing benchmark. It is also devoid of the idiosyncratic structural and supply factors that have distorted the shapes of the government bond yield curves in a number of important markets. Also much of the growth of the credit derivatives mar­ket would not have been possible without the development of models for the pricing and management of credit risk. There is an increasing sophistication in the market as market participants have developed a more quantitative ap­proach to analyzing credit. Electronic trading platforms such as CreditT4 ade (www.credittrade.com) and derivatives online CreditEx (www.creditex.com) appeared in the market. Both have proved successful and have had a significant impact in improving price discovery and liquidity in the credit derivative market.KeywordsCash FlowCredit RiskCredit Default SwapCredit SpreadCredit DerivativeThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.