Use KMV Model to Predict CDS Price Spread
Date Issued
2009
Date
2009
Author(s)
Cheng, Te-Hsun
Abstract
First, we introduce the overall concept about credit derivatives and compare the relative product character and difference. Then we discuss some models which the market often use to pricing credit default swap and compare these models’ advantage/disadvantage, usefulness and accuracy. Even we couldn’t predict very precisely, we want to find a relatively useful pricing method. We try to compare credit migration matrix, reduced-form model and KMV model, then we know that credit migration matrix can only separate credit rating from AAA to C. Reduced-form is useless because of lacking enough information like every firms’ yield curve. Even these firms like Dow Jones Components are still the same. So we choose KMV model as our empirical model for the dada, the model considerate about the market equity value, total debt, and equity volatility, including the market factors. Although it ignores the credit rating, we still recommend it. The reason is the rating agency give their rating is depending on the financial report or market information, so we can believe that the model is somehow reflect the real value in the CDS. Finally, we use the most people used and most accurate KMV model as our empirical model. We search for the Dow Jones Components and compare these CDS price and the model theoretical price. We found that the spread change a lot before and after the financial market crisis. We have done the regression by fixed effect panel data and show the pictures on the appendix.
Subjects
Risk management
Default Risk
Credit Default Swap
KMV Model
Credit Migration Matrix
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