System credit events and the valuation of credit default swaps

Taking system credit events as the carrier, we study the valuation of credit default swap adjusted by bilateral counterparty risk. Our study shows that: 1) a complete credit event set will form a system of credit risk and can be used as a valuation basis for credit default swaps(CDS); 2) in the CDS valuation, the default risk of buyer cannot be ignored. If it happens, a wrong price will emerge. Since the wrong price is lower than the reasonable one, the credit-protected seller will sustain losses; 3) the replacement cost of CDS deal cannot be ignored either. Because of the existence of the replacement cost, the value of CDS contracts will produce a supernormal change, depending on the current market price of the contract;4) the price of CDS is very sensitive to the credit value difference of the reference assets; the credit value difference will cause significant change in the price of CDS.