Credit Contingent Interest Rate Swap Valuation

A credit contingent interest rate swap is an option that grants its holder the right, but not the obligation, to enter into an interest rate swap (IRS) at the time when its reference obligor defaults. The premium to be paid on the underlying IRS is fixed in advance at some strike level. The notional amount of the swap is a function of a predetermined fixed amount and the recovery rate of the reference obligor. The model can also be employed to back out an implied correlation between the interest rate and the default arrival of an obligor.