An Evaluation Model for Fading Out Swap

Abstract

We construct a model for valuing Fading Out Swaps and characterize these claims. Fading Out Swaps are swap contracts whose payments of cashflows after default by either counterparty of swap contracts will be cancelled. Note that Fading Out Swaps are different from claims subject to default by both contracting parties proposed from Duffie and Huang or Jarrow and Turnbull. In Fading Out Currency Swaps, the fraction of market value paid to the non-defaulting party is zero when the swap has negative net market value for defaulting party, and also there is no compensate for defaulting party when the swap has positive net market value for defaulting party. While the valuation model applies to both Fading Out Interest Rate Swaps and Fading Out Currency Swaps, we focus on Fading Out Currency Swaps with an exchange of principal, implying an increase in counterparty risk.