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Department ofFinance

Selected Publications

Finance Professor Sanjiv Das Head Shot

Finance Professor Sanjiv Das Head Shot

Local Volatility and the Recovery Rate of Credit Default Swaps

Sanjiv Das

Forthcoming, Journal of Economic Dynamics and Control.

Abstract:

Credit default swap (CDS) spreads can only be decomposed into the probability of default and the loss-given-default by imposing some structure. Employinga hybrid binomial tree for equities and a recovery function, Das and Hanouna (2009)obtainaccurate estimates for CDS spreadsby fitting the model to historical equity volatilities. We extend their approach by including the full implied volatility surface,developingan implied binomial tree with a jump to default based on extending the Derman and Kani (1994)tree. We then evaluate the effect of including the full volatility surface on the implied CDS recovery rate.

 


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Research
LSB Research, Featured, FNCE