An Application of the Hull-White Model on CDS Spread Pricing

Abstract: This study illustrates in detail the Hull and White reduced-from model for pricing CDS spreads and applied the model to real bond data. Following the assumption of the model, that the yield spread between a defaultable bond and a default-free bond only captures the probability of default, we aim at calculating a number of static CDS spread. To attain the CDS spread for different reference entities with time to maturity 1 to 5 years on May 15th, 2009, bond prices are carefully collected with special attention to time to maturity and coupon payment. And then zero curves for both Treasury and corporate bonds are constructed using bootstrapping method and interpolation. Finally, theoretical default probabilities and CDS spread are calculated with recovery rate exogenously given as constant. Our results shows it might be the reason that the model is based on a theoretical framework with rather strict assumptions, it is incapable of adjusting to situations where factors deviate from the given assumptions, that the yield spread only captures credit risk. Therefore the model does not perform ideally in practice.