Abstract:

Sub-prime crisis calls for new pricing model of credit derivatives. So we propose a general equilibrium model with product market and capital market to price single-name CDS, and get the Walrasion equilibrium by means of optimization. It can be found that price of CDS in general equilibrium is mixed with factors of capital market and product market. So, it is not only that factors of capital market could affect price of CDS, but factors including risk-free rate, the output elasticity of capital, default rate and recovery rate. Then we examine the dynamics through quantity constrained equilibria out from Walrasion equilibrium by means of computer simulation, and find that price fluctuates acutely and quantity of transaction shrinks when default risk increases. In the process of pricing CDS with reference entity of Industrial and Commercial Bank of China (ICBC), it is found that each factor might be the key factor which affects price of CDS at different period. Lastly. It also can be found that there might be several problems in pricing system during sub-prime crisis, including adjustment of credit and disconnections of pricing and real economy. It can be considered that pricing of CDS based on product market and capital market in a general equilibrium model could mix cross effects of both market together and provide a direction for pricing of derivative.

Key words: general equilibrium, CDS, product market, capital market