2014/03/09 by M. B. Walker, Michael B. Walker, Walker, Michael B.
Decision Sciences · Economics, Econometrics and Finance · #Banking stability, regulation, efficiency #Credit Risk and Financial Regulations #FOS: Economics and business #Insurance and Financial Risk Management #Pricing of Securities (q-fin.PR) #Risk Management (q-fin.RM) #Risk and Portfolio Optimization #q-fin.PR #q-fin.RM
paper · pdf · doi:10.48550/arxiv.1403.2060
19 pages, 5 figures, submitted for consideration in International Journal of Theoretical and Applied Finance
arxiv created 2014/03/09 · openalex publication_date 2014/03/09 · arxiv updated 2014/03/11 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
Recently, incomplete-market techniques have been used to develop a model applicable to credit default swaps (CDSs) with results obtained that are quite different from those obtained using the market-standard model. This article makes use of the new incomplete-market model to further study CDS hedging and extends the model so that it is capable treating single-name CDS portfolios. Also, a hedge called the vanilla hedge is described, and with it, analytic results are obtained explaining the striking features of the plot of no-arbitrage bounds versus CDS maturity for illiquid CDSs. The valuation process that follows from the incomplete-market model is an integrated modelling and risk management procedure, that first uses the model to find the arbitrage-free range of fair prices, and then requires risk management professionals for both the buyer and the seller to find, as a basis for negotiation, prices that both respect the range of fair prices determined by the model, and also benefit their firms. Finally, in a section on numerical results, the striking behavior of the no-arbitrage bounds as a function of CDS maturity is illustrated, and several examples describe the reduction in risk by the hedging of single-name CDS portfolios.