An Overview of Credit Derivatives

Abstract

Credit risk is the distribution of nancial loss due to a broken nancial agreement, for example failure to pay interest or principal on a loan or bond. It pervades virtually all nancial transactions, and therefore plays a signicant role in nancial markets. A credit derivative is a security that allows investors to transfer credit risk to other investors who are willing to take it. By facilitating the allocation of risk, these instruments have an important economic function. Yet they have hit the headlines recently. This paper gives an overview of credit derivatives. It discusses the mechanics of standard contracts, describes their application, and outlines the mathematical challenges associated with their analysis.