Question
Suppose that default rates are stochastic and depend on the state of the economy. A Treasurer for a bank uses a simple model to value
Suppose that default rates are stochastic and depend on the state of the economy.
A Treasurer for a bank uses a simple model to value credit default swaps (CDS) on a firm. The model is:
CDS spread= (recovery rate)(actual default probability).
The Treasurer calibrates the model spread to the market spread to estimate the 1 year default probability on a firm. Is this the correct default probability? Explain.
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Fundamentals of Investments Valuation and Management
Authors: Bradford Jordan, Thomas Miller
7th edition
978-0078096785, 78096782, 978-0077861636, 77861639, 978-0078115660
