Advanced

An Application of the Hull-White Model on CDS Spread Pricing

Li, Manshu and Wright, Sebastian (2009)
Department of Economics
Abstract
This study illustrates in detail the Hull and White reduced-from model for
pricing CDS spreads and applied the model to real bond data.
Following the assumption of the model, that the yield spread between a
defaultable bond and a default-free bond only captures the probability of
default, we aim at calculating a number of static CDS spread. To attain the
CDS spread for different reference entities with time to maturity 1 to 5 years
on May 15th, 2009, bond prices are carefully collected with special attention to
time to maturity and coupon payment. And then zero curves for both
Treasury and corporate bonds are constructed using bootstrapping method
and interpolation. Finally, theoretical default probabilities and CDS spread
are calculated... (More)
This study illustrates in detail the Hull and White reduced-from model for
pricing CDS spreads and applied the model to real bond data.
Following the assumption of the model, that the yield spread between a
defaultable bond and a default-free bond only captures the probability of
default, we aim at calculating a number of static CDS spread. To attain the
CDS spread for different reference entities with time to maturity 1 to 5 years
on May 15th, 2009, bond prices are carefully collected with special attention to
time to maturity and coupon payment. And then zero curves for both
Treasury and corporate bonds are constructed using bootstrapping method
and interpolation. Finally, theoretical default probabilities and CDS spread
are calculated with recovery rate exogenously given as constant.
Our results shows it might be the reason that the model is based on a
theoretical framework with rather strict assumptions, it is incapable of
adjusting to situations where factors deviate from the given assumptions, that
the yield spread only captures credit risk. Therefore the model does not perform ideally in practice. (Less)
Please use this url to cite or link to this publication:
author
Li, Manshu and Wright, Sebastian
supervisor
organization
year
type
H1 - Master's Degree (One Year)
subject
keywords
credit default swap, Yield Spread, CDS spread, Hull and White model., Economics, econometrics, economic theory, economic systems, economic policy, Nationalekonomi, ekonometri, ekonomisk teori, ekonomiska system, ekonomisk politik
language
English
id
1511508
date added to LUP
2009-11-10 00:00:00
date last changed
2010-08-03 10:52:58
@misc{1511508,
  abstract     = {This study illustrates in detail the Hull and White reduced-from model for
pricing CDS spreads and applied the model to real bond data.
Following the assumption of the model, that the yield spread between a
defaultable bond and a default-free bond only captures the probability of
default, we aim at calculating a number of static CDS spread. To attain the
CDS spread for different reference entities with time to maturity 1 to 5 years
on May 15th, 2009, bond prices are carefully collected with special attention to
time to maturity and coupon payment. And then zero curves for both
Treasury and corporate bonds are constructed using bootstrapping method
and interpolation. Finally, theoretical default probabilities and CDS spread
are calculated with recovery rate exogenously given as constant.
Our results shows it might be the reason that the model is based on a
theoretical framework with rather strict assumptions, it is incapable of
adjusting to situations where factors deviate from the given assumptions, that
the yield spread only captures credit risk. Therefore the model does not perform ideally in practice.},
  author       = {Li, Manshu and Wright, Sebastian},
  keyword      = {credit default swap,Yield Spread,CDS spread,Hull and White model.,Economics, econometrics, economic theory, economic systems, economic policy,Nationalekonomi, ekonometri, ekonomisk teori, ekonomiska system, ekonomisk politik},
  language     = {eng},
  note         = {Student Paper},
  title        = {An Application of the Hull-White Model on CDS Spread Pricing},
  year         = {2009},
}