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Credit default swaps in their current form have existed since the early 1990s and increased in use in the early 2000s. By the end of 2007, the outstanding CDS amount was $62.2 trillion, [3] falling to $26.3 trillion by mid-year 2010 [4] and reportedly $25.5 [5] trillion in early 2012.
The Z-spread of a bond is the number of basis points (bp, or 0.01%) that one needs to add to the Treasury yield curve (or technically to Treasury forward rates) so that the Net present value of the bond cash flows (using the adjusted yield curve) equals the market price of the bond (including accrued interest).
A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities. Unlike a credit default swap, which is an over the counter credit derivative, a credit default swap index is a completely standardized credit security and may therefore be more liquid and trade at a smaller bid–offer spread.
The Jarrow–Turnbull model is a widely used "reduced-form" credit risk model. It was published in 1995 by Robert A. Jarrow and Stuart Turnbull. [1] Under the model, which returns the corporate's probability of default, bankruptcy is modeled as a statistical process.
Default probabilities may also be estimated from the observable prices of credit default swaps, bonds, and options on common stock. The simplest approach, taken by many banks, is to use external ratings agencies such as Standard and Poors , Fitch or Moody's Investors Service for estimating PDs from historical default experience.
A Credit valuation adjustment (CVA), [a] in financial mathematics, is an "adjustment" to a derivative's price, as charged by a bank to a counterparty to compensate it for taking on the credit risk of that counterparty during the life of the transaction. "CVA" can refer more generally to several related concepts, as delineated aside.
The Merton model, [1] developed by Robert C. Merton in 1974, is a widely used "structural" credit risk model. Analysts and investors utilize the Merton model to understand how capable a company is at meeting financial obligations, servicing its debt, and weighing the general possibility that it will go into credit default.
In 1996 the outstanding notional value of credit derivatives (credit default swaps (CDSs)) was $40 billion. [3] By the end of 2001 it was approximately $1.2 trillion. By 2004 it was expected to be $4.8 trillion. Credit default swaps (CDSs) accounted for roughly 45% of the overall credit derivatives market in 2002.(Packer & Suthiphongchai 2003, p.