Credit risk and credit derivatives: an analysis of the market of CDS

Abstract

One of the most important risk for both financial institutions and private investors is credit risk. Credit risk arises from the possibility that the borrower defaults and does not pay back its debt causing a loss for the lender, but also, from the possibility that the creditworthiness of the borrower will deteriorate, affecting its ability to pay back its debt and the value of the investment. Credit risk has acquired a growing importance in the last two decades, which have been characterized by several financial disasters, started in 2007 with the US subprime mortgage crisis. In addition from the end of 2009, we could also observed at European level an increasing number of states such as Greece, Portugal, Ireland and Spain which were unable to repay their debt. As a result of such difficulties, it is increasingly felt the need of a correct management of credit risk and the creation of operations and financial instruments, which make it possible to negotiate this risk. In this thesis, I will analyze the main components of credit risk, then credit derivatives and in particular the valuation of Credit Default Swaps.