Hostname: page-component-cd9895bd7-dzt6s Total loading time: 0 Render date: 2024-12-27T06:21:18.015Z Has data issue: false hasContentIssue false
  • English
  • Français

Credit Derivatives. Prepared by the Derivatives Working Party of the Faculty and Institute of Actuaries

Published online by Cambridge University Press:  10 June 2011

M. J. Muir ,
A. Chase ,
P. S. Coleman ,
P. Cooper ,
G. S. Finkelstein ,
P. Fulcher ,
C. Harvey ,
F. R. Pereira ,
A. Shamash  and
T. J. D. Wilkins
M. J. Muir
Affiliation:
Watson House, London Road, Reigate, Surrey RH2 9PQ, U.K. Tel: +44(0)1737 274 128; Email: [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper was written by the Derivatives Working Party, a permanent working party of the Life Research Committee of the Institute and Faculty of Actuaries. Our aim is to consider how life assurers may use, or may wish to use, derivatives, and if their use is unduly constrained, e.g. by regulation. This paper focuses on credit derivatives. We provide an overview of the credit derivatives market, and the strong growth in this market over recent years. We then focus on the two main traded credit derivative instruments — Credit Default Swaps (CDSs) and Collateralised Debt Obligations (CDOs). We explain how these instruments work and are priced, and clarify some of the more complex topics involved, such as the settlement of CDSs, basis risk and the relevance of implied correlation in pricing CDOs. We then consider how life insurers could make use of credit derivatives, for example to provide more efficient investment management in taking exposure to credit risk, or to hedge credit exposures, and consider the regulatory implications of so doing. Finally, in the Appendix, we discuss the credit spread puzzle, and the existence or otherwise of a liquidity premium in corporate bond spreads, with implications for the valuation of illiquid liabilities.

Keywords

Credit DerivativesCredit Default Swaps (CDSs)Collateralised Debt Obligations (CDOs)ISDACredit EventDefaultSettlementCheapest-to-DeliverBasisTrancheLeverageCorrelationAdmissibilityEfficient Portfolio ManagementCredit Spreadz-SpreadLiquidity PremiumCredit Risk PremiumDerivatives for Life Insurers
Type
Sessional meetings: papers and abstracts of discussions
Information
British Actuarial Journal , Volume 13 , Issue 2 , 01 July 2007 , pp. 185 - 236
Copyright
Copyright © Institute and Faculty of Actuaries 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Altman, E.I. (1989). Measuring corporate bond mortality and performance. Journal of Finance, 44, 902–922.CrossRefGoogle Scholar
Amato, J.D. & Remolana, E.M. (2003). The credit spread puzzle. BIS Quarterly Review, 5, December 2003, 51–63.Google Scholar
Baggs, I., Cannon, D., Holman, R., Middleton, P., Pagett, T. & Winckler, A. (2003). Credit derivatives. Ernst & Young report.Google Scholar
British Bankers' Association (2003/2004). Credit derivatives survey.Google Scholar
Bank for International Settlements (September 2005). Quarterly review.Google Scholar
Collin-Dufresne, P., Goldstein, R.S. & Helwege, J. (2003). Is credit event risk priced? Modelling contagion via the updating of beliefs. Working paper, Carnegie Mellon University.Google Scholar
Dionne, G., Gauthier, G., Hammami, K., Maurice, M. & Simonato, J.G. (2004). Default risk on corporate yield spreads. Working paper, HEC Montreal.Google Scholar
Dorey, M. & Joubert, P. (2005). Modelling copulas: an overview. Paper presented to the Staple Inn Actuarial Society.Google Scholar
Driessen, J. (2005). Is default event risk priced in corporate bonds? Review of Financial Studies, 18, 165–195.CrossRefGoogle Scholar
Dyer, D., Crouch, S., Eason, S., Fulcher, P. & Jolly, P. (2004). Fixed interest investment for life insurers — driven by investment principles or regulation? Paper presented to the Joint Faculty and Institute of Actuaries Investment Conference, 2004.Google Scholar
Elton, E.J., Gruber, M.J., Agrawal, D. & Mann, C. (2001). Explaining the rate spread on corporate bonds. The Journal of Finance, LVI, No. 1.Google Scholar
Fama, F. & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3–56.CrossRefGoogle Scholar
Huang, J. & Huang, M. (2003). How much of the corporate-treasury yield spread is due to credit risk. Working paper, Stamford University.Google Scholar
Hull, J.C. (2004). Ocutions, futures and other derivatives. Prentice Hall.Google Scholar
Hull, J.C., Predes, M. & White, A. (2003). Bond prices, default probabilities and risk premiums. Working paper, University of Toronto.Google Scholar
Li, H., Shi, J. & Wu, C. (2005). Estimating liquidity premium of corporate bonds using the spread information in on- and off- the run treasury securities. Working paper.Google Scholar
Longstaff, F.A. (2004). The flight-to-liquidity premium in U.S. Treasury bond prices. Journal of Business, 77, 511–526.CrossRefGoogle Scholar
Longstaff, F.A., Mithal, S. & Neis, E. (2004). Corporate yield spreads: default risk or liquidity? New evidence from the credit-default swap market. Working paper, UCLA.CrossRefGoogle Scholar
Moody's (2005). Default and recovery rates of corporate bond issuers, 1920-2004. Moody's Investor Services.Google Scholar
Perruadin, R.M. & Taylor, A.P. (2003). Liquidity and bond market spreads. Working paper, Bank of England.CrossRefGoogle Scholar
Smith, A.D. (2004). Modelling corporate bonds. Paper presented to Institute and Faculty of Actuaries Current Issues in Life Assurance Conference, 2004.Google Scholar