Credit Default Swaps from an Equity Option View

  • Mathias Schmidt
Part of the SpringerBriefs in Finance book series (BRIEFSFINANCE)


We compare the implied probability of default on the credit market and on the equity market of the same underlying. In order to compare these two different markets, we use the price of premium leg of a CDS contract as the price for an American digital option. If called, this option pays the same amount as the protection seller (CDS) in a credit event. The applied volatility will be extracted from implied volatility surface. Via an optimization procedure we find the corresponding strike to the option price which we call “strike of default”. This number can be seen as a risk measure or an individual hedging limit for this underlying hence the markets assume a default at this share price with the maturity of the CDS.


Stock Price Option Price Credit Default Swap Share Price Implied Volatility 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.


  1. G. Angelopoulus, D. Giamouridis, G. Nikolakakis, Stock return predictability of cross-market deviations in option prices and credit default swap spreads. Available at SSRN 1991179 (2012, January)Google Scholar
  2. D.S. Bates, Jumps and stochastic volatility: exchange rate processes implicit in Deutsche Mark options. Rev. Finan. Stud. 9(1), 69–107 (1996)CrossRefGoogle Scholar
  3. F. Black, M.S. Scholes, The pricing of options and corporate liabilities. J. Polit. Econ. (7), 637–654 (1973)Google Scholar
  4. H. Byström, Credit default swaps and equity prices: The iTraxx CDS index market. Working Papers, Department of Economics, Lund University 24 (2005)Google Scholar
  5. C. Cao, F. Yu, Z. Zhong, The information content of option-implied volatility for credit default swap valuation. J. Finan. Markets 13(3), 321–343 (2010)CrossRefGoogle Scholar
  6. P. Carr, L. Wu, A simple robust link between American puts and credit protection. Rev. Finan. Stud. 24(2), 473–505 (2011)CrossRefGoogle Scholar
  7. P. Carr, L. Wu, Stock options and credit default swaps: a joint framework for valuation and estimation. J. Finan. Econometrics (2009): nbp010Google Scholar
  8. P. Collin-Dufresne, R. Goldstein, J. Martin, The determination of credit spread changes. J. Finance 56(6), 2177–2207 (2001)CrossRefGoogle Scholar
  9. J. Cox, J. Ingersol Jr., S. Ross, A theory of the term structure of interest rates, 385–408 (1985)Google Scholar
  10. S.L. Heston, A closed-form solution for options with stochastic volatility with applications to bond and currency options. Rev. Finan. Stud. 6(2), 327–343 (1993)CrossRefGoogle Scholar
  11. J.C. Hull, Options, futures, and other derivatives, 5th edn. (Pearson Education, Harlow, England, 2012)Google Scholar
  12. J.C. Hull, I. Nelken, A. White, Merton’s model, credit risk, and volatility skews. J. Credit Risk 1(1), 8–23 (2004)Google Scholar
  13. R.C. Merton, On the pricing of corporate debt: The risk structure of interest rates. J. Finance 29(2), 449–479 (1974)Google Scholar
  14. M.F. Schmidt, Credit default swaps from an equity point of view. World Finance Conference (2014)Google Scholar
  15. P. Wilmott, Paul Wilmott on quantitative finance (John Wiley & Sons, 2013)Google Scholar
  16. B.Y. Zhang, H. Zhou, H. Zhu, Explaining credit default swap spreads with the equity volatility and jump risks of individual firms. Rev. Finan. Stud. 22(12), 5099–5131 (2009)CrossRefGoogle Scholar

Copyright information

© The Author(s) 2016

Authors and Affiliations

  • Mathias Schmidt
    • 1
  1. 1.HamburgGermany

Personalised recommendations