The extra yield that a company pays when it issues a bond includes compensation for the expected loss on default and for uncertainty about the default probability, and also for factors such as the lower market liquidity of corporate bonds1.

To compute CVA, the default probability under the risk-neutral measure is estimated from credit spreads observed in the market. The spread of a CDS that references the counterparty directly is regarded as the most reliable. Without one, the spread of the counterparty's bonds or of a CDS on a similar company is used instead.

A 2017 paper by the Institute for Monetary and Economic Studies of the Bank of Japan (Yuichi Saito) calls the symbol λ\lambda, the default intensity in the valuation formula, a "credit spread". This site writes λ\lambda as the hazard rate and uses credit spread for a yield difference or a CDS spread. Consider a hypothetical example in which a government bond yields 1.0% and a corporate bond of the same maturity yields 1.5%. The credit spread is 0.5% (50bp). The change in value for a 1bp move in the spread is called the CS01.

Notes

  1. Bank of Japan, "日本の社債発行スプレッドの変動要因" (Determinants of corporate bond issuance spreads in Japan; in Japanese). ↩