Bridge over ocean
1 July 2011 Financial Analysts Journal Volume 67, Issue 4

Pricing Credit Default Swaps with Option-Implied Volatility

  1. Charles Cao
  2. Fan Yu
  3. Zhaodong Zhong

Using the industry benchmark CreditGrades model to analyze credit default swap (CDS) spreads across a large number of companies during the 2007–09 credit crisis, the authors demonstrate that the performance of the model can be significantly improved by calibrating it with option-implied volatility rather than with historical volatility. Moreover, the advantage of using option-implied volatility is greater among companies with more volatile CDS spreads, more actively traded options, and lower credit ratings.

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