Pricing Credit Default Index Swaptions A numerical evaluation of pricing models
Credit Default Index SwaptionsOptions on CDS IndicesCredit DerivativesCredit Default SwapCredit Default SwaptionCredit Default Index SwapCredit RiskCredit Risk ModellingIntensity-based Mod- ellingBlack-Scholes
This study examines the background and nature of the credit default index swaption (CDIS) and presentsrelevant methods for modelling credit risk. A CDIS is a credit derivative contract that gives the buyerright to enter into a credit default index swap (CDS index) contract at a given point in time. ACDS index, in turn, is a multi-name credit default swap (CDS). Within the eld of research, thisthesis identi es the CDIS pricing models presented by Jackson (2005), Rutkowski & Armstrong (2009)and Morini & Brigo (2011) as the most recognized and developed. These models are evaluated byreconstruction in a numerical software environment. Although the considered models are well-behavingunder economic interpretation, they di er in constructional features regarding whether to model theso-called Armageddon event inside or outside the Black (1976) model. An Armadageddon event refersto a total default of the CDS index up to the expiry of the CDIS. Based on the criteria of requiredassumption boldness and calculation transparency, the model presented by Morini & Brigo (2011) havebeen evaluated in depth. The expected value of the front-end protection, i.e. the insurance againstdefault events during the lifetime of the CDIS, is found to increase with pairwise correlation amongreference names and the e ect of the Armageddon scenario is only observable as the pairwise correlationapproaches one. This implies that the choice of pricing model is found to be crucial during stressedeconomic climates and of less importance during calm economic climates.