%0 Journal Article %A Nikola Tarashev %A Haibin Zhu %T The Pricing of Correlated Default Risk %B Evidence from the Credit Derivatives Market %D 2008 %R 10.3905/jfi.2008.708840 %J The Journal of Fixed Income %P 5-24 %V 18 %N 1 %X Observed tranche spreads of a popular credit default swap (CDS) index reflect the pricing of portfolio credit risk, which we benchmark against “predicted” tranche spreads implied by the single-name CDS market. The overall levels and time profiles of the two sets of spreads reveal that the index and single-name markets are in agreement regarding the risk-neutral probabilities of default (PDs) associated with individual credit exposures. However, substantial tranche-specific differences between observed and predicted spreads suggest that the physical asset return correlations, which are extracted from the single-name market, are too low to account for prices of portfolio credit risk. We explain much of these differences via a correlation risk premium, which amounts on average to 66% of the physical correlations over our sample period.TOPICS: Credit default swaps, credit risk management, statistical methods, analysis of individual factors/risk premia %U https://jfi.pm-research.com/content/iijfixinc/18/1/5.full.pdf