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Credit Delta and Credit VaR Credit default swaps may terminate prior to maturity if the obligor defaults. The effective duration of a credit default swap is therefore shorter than the term of the swap due to the possibility of swap termination prior to maturity. The current methodology overstates PV01 values because it does not incorporate the default probability. Since high level of credit spread is a result (and an indication) of high default probability, the reduction in PV01 values is significant for high spread transactions. For transactions with low credit spread (less than 200 bps), the difference is negligible. Calculate rating-level CVaR values by multiplying the net PV01 values for each rating by the credit spread volatility factors for that rating. The credit spread volatility factor is the 1-day movement at the 99% confidence level based on the 2-year credit spread for a particular rating band. Credit spread information derived from debt securities is only an approximation to the swap spread data and may not truly reflect the level and volatility of swap spreads. Therefore credit spreads of debt securities should only be used as a proxy in the absence of historical spread data for asset swaps and default swaps. The levels as well as volatilities of credit spreads vary significantly within a rating band. The spread volatility of an index of similarly rated bonds can be significantly smaller than that of an individual obligor due to diversification effect. It is therefore necessary to calculate and apply volatilities at the obligor level rather than at the rating level.
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