New model predicts market losses from counterparty default in credit swaps.
The article introduces a new way to price Credit Default Swaps (CDS) that includes the risk of the other party not being able to pay. This model helps to better allocate economic capital and follows the rules of Basel III. The researchers use a special statistical tool called a mixture copula to understand how the risks of both parties are related. They find that the CDS can be very risky in extreme situations, and their model can calculate prices accurately.