Valuation of Credit Default Swaps

This technical paper provides a detailed methodology for the valuation of Credit Default Swaps (CDS) within the UnRısk framework. 

A Credit Default Swap is a financial derivative used for hedging against the default risk of a counterparty, with payouts determined by the default event and recovery rate. The paper describes the construction of CDS curves, which are defined by the maturities of the swaps and their corresponding "fair" credit spreads. It presents the mathematical formulation required to ensure that the value of a newly entered CDS is zero at inception, incorporating factors such as hazard rates, survival probabilities, and risk-free discount factors.

Additionally, the paper outlines the process for calculating both the dirty and clean values of a CDS. The dirty value is derived by bootstrapping hazard rates from a given CDS curve and comparing the implied credit spread with the actual credit spread of the swap. The clean value is then obtained by adjusting the dirty value for accrued interest. This comprehensive approach enables precise pricing and risk assessment of CDS instruments in various market conditions.