RT Journal Article
SR Electronic
T1 Problems with Using CDS to Infer Default Probabilities
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 6
OP 12
DO 10.3905/jfi.2012.21.4.006
VO 21
IS 4
A1 Robert A. Jarrow
YR 2012
UL https://pm-research.com/content/21/4/6.abstract
AB Using credit default swaps (CDS) to imply a firm’s or sovereign’s default probability is laden with difficulties, making the resulting estimate unreliable. This article exposes these difficulties using a simple analogy to life insurance premiums. An analogy is used because the logic is more easily understood in this context. The difficulties are unraveling the impact of risk premium, counterparty risk, market frictions, and strategic trading. Given a well-understood alternative to implied CDS default probabilities is available, actuarial-based default probabilities, banking regulations and risk management decisions should not be based on CDS implied default probabilities.TOPICS: Credit default swaps, credit risk management, big data/machine learning, counterparty risk