A large literature exists that attempts to explain why similar products sell for different prices. For example, Lach (2002) documents considerable price dispersion for similar refrigerators, chicken, coffee, and flour. He concludes that because stores change their pricing on a regular basis, consumers cannot learn which stores are the low cost sellers, and as a consequence, price dispersion persists.
Almost two years ago, the Payment Cards Center hosted a workshop at which several regional consumer credit counseling services (CCCS) discussed the changes in the credit counseling and debt management industry. Historically, not-for-profit CCCS organizations have taken a holistic approach to helping consumers. They use face-to-face budget counseling and debt management programs (DMPs) to help people regain control of their finances.
This paper provides a methodology for valuing credit default swaps when the payoff is contingent on default by a single reference entity and there is no counterparty default risk. The paper tests the sensitivity of credit default swap valuations to assumptions about the expected recovery rate. It also tests whether approximate no-arbitrage arguments give accurate valuations and provides an example of the application of the methodology to real data. In a companion paper entitled Valuing Credit Default Swaps II: Modeling Default Correlation, the analysis is extended to cover situations where the payoff is contingent on default by multiple reference entities and situations where there is counterparty default risk.
Credit default swaps have become increasingly popular in recent years. Their purpose is to allow credit risks to be traded and managed in much the same way as market risks. In 1998, trading in credit default swaps was facilitated by standard documentation produced by the International Swaps and Derivatives Association.
