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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 CDS basis is commonly the CDS fee minus the Z-spread for a fixed-rate cash bond of the same issuer and maturity. For instance, if a corporation's 10-year CDS is trading at 200 bp and the Z-spread for the corporation's 10-year cash bond is 287 bp, then its 10-year CDS basis is –87 bp.
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 credit default swap or CDS has become the cornerstone product of the credit derivatives market. This product represents over thirty percent of the credit derivatives market. [5] The product has many variations, including where there is a basket or portfolio of reference entities, although fundamentally, the principles remain the same.
The option is usually European, exercisable only at one date in the future at a specific strike price defined as a coupon on the credit default swap. Credit default options on single credits are extinguished upon default without any cashflows, other than the upfront premium paid by the buyer of the option. Therefore, buying a payer option is ...
where is the maturity of the longest transaction in the portfolio, is the future value of one unit of the base currency invested today at the prevailing interest rate for maturity , is the loss given default, is the time of default, () is the exposure at time , and (,) is the risk neutral probability of counterparty default between times and .
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.
This is achieved by buying, for example, credit default swaps: this "CDS protection" applies in that its value is driven, also, by the counterparty's credit worthiness. [25] Hedges can also counter the variability of the exposure component of CVA risk, offsetting PFE at a given quantile.