Question

Does valuing a CDS using real-world default probabilities rather than risk-neutral default probabilities overstate or understate its value? Explain your answer.

   Does valuing a CDS using real-world default probabilities rather than risk-neutral default probabilities overstate or understate its value? Explain your answer.

Options, Futures, and Other Derivatives

Options, Futures, and Other Derivatives

John C. Hull 10th Edition

Chapter 25, Problem 19

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A Credit Default Swap (CDS) is a financial derivative instrument that allows an investor to transfer the credit risk of a specific underlying asset, such as a bond or loan, to another party. In exchange for regular premium payments, the party selling the CDS Show more…

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Does valuing a CDS using real-world default probabilities rather than risk-neutral default probabilities overstate or understate its value? Explain your answer.

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