Pricing Corporate and Sovereign Credit Default Swaps

Summary

For hard-currency credit default swaps, the response says the pricing calculations are the same across corporate, sovereign, agency, and municipal reference entities. Recovery assumptions should follow market conventions, which can vary by issuer type and market. The text provides example assumptions but no pricing formula or worked valuation.

Local-currency sovereign CDS require an additional quanto factor to account for the assumed relationship between the currency and sovereign default on hard-currency debt. The response also separates market pricing from estimating physical default probabilities: corporate financial-ratio models may be feasible when public stock and financial statements are available, while the same approach generally cannot be applied to sovereigns. These points are concise guidance; the treatment does not detail calibration, market conventions, or the construction of the quanto adjustment.

Key ideas

• Hard-currency CDS pricing calculations do not change solely because the reference entity is sovereign rather than corporate.
• Recovery assumptions should reflect conventions for the relevant issuer and market.
• Local-currency sovereign CDS pricing should account for a quanto factor tied to currency behavior during default.
• Market CDS pricing differs from estimating physical default probabilities using financial statements.

Tags

# How is valuing corporate CDS different from sovereign CDS?


# How is valuing corporate CDS different from sovereign CDS?












How are they different? I have done some corporate CDS valuations but I want to know how to value sovereign CDS. Thanks!

## Answer by Dimitri Vulis (score 2)

https://quant.stackexchange.com/a/43588

For pricing a hard currency denominated CDS, it does not matter whether the reference entiry is corporate, sovereign, agency, muni, etc. The calculations are the same. Do try to use market conventions for your recovery assumptions - many people assume 40% for corporates, 25% for emerging markets sovereigns.

If the CDS is in local currency, then you should include a "quanto factor" in your calculation. It is your assumption of how the local currency would be affected if the sovereign defaults on its (hard-currency) debt.

But if by valuing you meant not pricing, but something similar to Altman's Z-score, Moody's KMV, etc - estimating the physical probability of default by looking at various ratios from financial statements - then generally this can be done for corporates with publicly traded stock, so financial statements are available; and cannot be done for sovereigns.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.