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Risk assessment of credit default swaps

Author: ZhangJing
Tutor: LiZhongMin
School: Shaanxi Normal University
Course: Political Economics
Keywords: VaR model Historical Simulation Credit Default Swap CreditMetrics model
CLC: F224
Type: Master's thesis
Year: 2011
Downloads: 172
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Abstract


Credit Default Swap (CDS) as financial derivatives is a kind of risk management tool and insurance of financial assets against default. In 1995 J.P. Morgen create this product at first to solve the liquidity problem of credit risk. It means that the CDS contract can be used to transfer the default risk to a third party at cost, which can make the credit risk be traded as market risk. Since this innovative product provides an effective protection for the bank loans in the 1997 Asian financial crisis, most of the international financial institutions tend to participant in this market. Then Credit Default Swaps market is booming. However, the implementation of Credit Default Swaps is lack of government regulation. And it did not establish a central clearing system and improve the information mechanism, which makes the global Credit Default Swap market is at asymmetric-information risk and the default risk can not be estimated correctly. Particularly, since 2007 the global financial crisis, the risk assessment for Credit Default Swaps has caused widespread concern in global financial institutions. How to develop an effective risk assessment model for this new financial derivative has become one of the hot issues. Value at Risk model (VaR) has been one of the classical models to assess risk of financial products in the international financial institutions. But the traditional Value at Risk model considers only the market risk of financial assets, not yet including credit risk. In 2007 J.P. Morgen developed CreditMetrics model to measure credit risk for financial products. In his thesis we combine the CreditMetrics model and the traditional Value at Risk model to measure the risk of Credit Default Swaps (CDS).In this thesis, we use analysis, comparison and empirical analysis and other methods to finish this study. We combine the CDS pricing model to construct two new models to assess the risk of CDS contracts:exponentially weighted historical simulation method to calculate VaR for CDS (EWHS) and based on CreditMetrics model to assess VaR for CDS. This is one of the new ideas for this thesis.We also use the two new models to measure the risk of the single CDS contracts for 10 German companies. We also use VaR test and analysis to show that based on CreditMetrics model to measure the risk of CDS is better than another one. In particular for the lower credit rating companies, based CreditMetrics model can effectively assess the credit risk of CDS contract. It provides useful information for the financial institutions to predict risk and provision of adequate capital. This Thesis also provides some suggestions to improve the two new models. Since some simulation results have deficiencies with two models.The CDS market has just started in China. Since CDS product has "double-edged" effect and lack of supervision. The risk assessment management becomes one of the challenges for the CDS market. According to the first four chapters which is form of the theoretical basis and empirical analysis, we analyse the five potential risk for the CDS market in the future. We also propose some recommendations for the Chinese financial institutions when they use the two models to measure the credit risk of CDS contract.

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CLC: > Economic > Economic planning and management > Economic calculation, economic and mathematical methods > Economic and mathematical methods
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