In this paper, we analyze the pricing of contingent credit default swaps (CCDSs), which provide protection against default losses in derivative transactions. In a framework with both asset and interest rate risk, we obtain a meaningful semi-analytical solution for CCDS prices with an interest rate swap as underlying. Our model yields three major contributions:
- CCDSs have several properties that fundamentally differ from those of CDSs, despite the similar nature of the two instruments.
- We propose simple approximate pricing formulas for CCDSs. While the first one only depends on the prices of observable traded assets, ie, the CDS quote, the value of a swaption and a zero-bond, the second approximation formula additionally requires volatility information.
- We find that the approximate formulas work well in practical situations and converge to the true value for a financial institution with low default risk.