A Simple Non-Parametric Approach to the Term Structure and Time Decomposition of Credit Default Swap Spreads

Abstract

This study introduces a simple non-parametric approach to pricing credit default swaps (CDS) and other single-name credit-risky securities. The method relies exclusively on closed-form solutions, allows any term structure of CDS spreads to be reproduced, and implies lower pricing errors than conventional models. The study extends the theme by providing an equally simple and intuitive approach to the time decomposition of CDS spreads, which is similar to, but also remarkably different from the traditional decomposition of spot risk-free rates into forward rates. The overall research conclusions are supported by a case study of the Eurozone sovereign debt crisis.