JP Morgan's credit default swap (CDS) Analytical Engine will be released as open source code soon via the International Swaps and Derivatives Association (Isda). Isda believes the model - which is used to price CDS contracts - will increase transparency regarding CDS pricing.The Analytical Engine requires three inputs: a CDS quote, recovery rate and the interest rate discount curve. After stress-testing using a set of implied default probabilities consistent with past CDS quotes, recoveries and interest rates, there is a separate function that prices the unwind value of any CDS contract that is off par.
"All market participants can benefit from greater CDS standardisation and transparency," says Anil Bangia, executive director in JP Morgan's quantitative research group. "Our effort with Isda is another step in that direction, which will allow market participants to get exact agreement on their valuations, and will facilitate industry-wide initiatives such as electronic trading and central CDS clearing."
JP Morgan began to develop the model just under a decade ago, aiming to promote liquidity in the CDS market through increased pricing transparency for unwinding trades. It has since become widely used in the industry.
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