On the lognormality of forward credit default swap spreads

George Jabbour (), Fatena El Masri () and Stephen Young ()
Additional contact information
George Jabbour: The George Washington University, Postal: 2201 G Street NW, Funger Hall Suite 501, Washington DC 20052, USA
Fatena El Masri: E-Trade, Postal: E-Trade Financial Corporation, Risk Management Group 6520 Tucker Ave, McLean, VA 22101
Stephen Young: Evergreen Investments, Postal: 410 South Tryon Street, NC 0637, Charlotte, NC 28203

Journal of Financial Transformation, 2008, vol. 22, 41-48

Abstract: The market for credit default swaps continues to grow in terms of the number of underlying traded names and transactions as well as notional volumes outstanding. With the growth in credit default swaps it is natural to expect a market for options on credit default swaps to follow. Options on credit default swaps exist but are thinly traded via the over-the-counter market and the current modeling paradigm is based on the Black-Scholes framework. The underlying for an option on a credit default swap is the forward credit default swap spread for a particular reference entity. This paper examines the statistical properties of forward default swap spreads and strongly rejects the hypothesis that they are lognormally distributed. Furthermore, the analysis in this paper rules out credit migrations as the sole cause for the significant deviation from normality.

Keywords: Credit derivatives; credit risk; credit default swaps; options on credit default swaps; credit default swaptions (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ris:jofitr:0870

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