Swap Rates and Credit Quality




    Search for more papers by this author
    • * Duffie is from the Graduate School of Business, Stanford University, and Huang is from the Graduate School of Business, University of Chicago. We are grateful for discussions with Ken Singleton and comments from Kerry Back, Peter DeMarzo, Philip Dybvig, John Hull, Francis Longstaff, Dilip Madan, Jesús Saá-Requejo, Eduardo Schwartz, Ashok Varadhan, and Zvi Wiener.


This article presents a model for valuing claims subject to default by both contracting parties, such as swaps and forwards. With counterparties of different default risk, the promised cash flows of a swap are discounted by a switching discount rate that, at any given state and time, is equal to the discount rate of the counterparty for whom the swap is currently out of the money (that is, a liability). The impact of credit-risk asymmetry and of netting is presented through both theory and numerical examples, which include interest rate and currency swaps.