Gustav Bengtsson and Camilla Bjurhult

Present their master thesis

Equitity Based Modelling of Credit Default Swaps 
	
Abstract

Investing and trading in the credit default swap market can significantly
benefit from using equity data as an additional source of
information, due to the superior liquidity in the stock
market compared to the CDS market. In this Master's thesis the
performance of a purely equity-based CDS pricing model, with a
 slightly altered version of the stopped CEV model describing the equity
movements, will be evaluated. Particularly, two highly relevant
potential model applications are examined: model-based delta
hedging and CDS trading.

The results from the trading on the CDS market are quite promising,
the applied model appears to be effective in predicting the CDS spread
fluctuations, and hereby manages to induce a profit for most companies
studied. The delta hedging abilities of the model are not as
impressive, though the best results are obtained for companies with
low credit ratings. Moreover, when extending the trading portfolio
with the modelled delta hedge the risk exposure of the trading strategy
is noticeably reduced.