This thesis presents appropriate models for pricing CLN(Credit Linked Notes) traded in Korea. CLN entails the combination of a fixed income security with embedded credit derivatives like credit default swaps. In determining the fair value of CLN, estimating default probability density and default correlation is an important task. This study is using Hull and White(2000) model, which provides a methodology for valuing credit default swaps and credit basket swaps. Also, as a reference, this study is using simple JP Morgan model, which is an approach for valuing credit default swaps with simplified JP Morgan methodology. We are pricing CLN as a combination of credit default swaps(or credit basket swaps) and usual investment grade bonds with an assumption of no counter party risk.
As a result, in the case of CLN with embedded credit default swaps, the Hull and White(2000) model and the simple JP Morgan model seemed to be appropriate for pricing CLN traded in Korea. But in the case of CLN with embedded credit basket swaps, the Hull and White(2000) model overvalued market prices with lower default correlation. We test the sensitivity of CLN prices to assumptions about the asset correlation and the expected recovery rate.
