I came across this:“The hazard rate affects the protection leg: the higher the hazard rate, the higher the expected value of payoffs made by the protection seller upon default. Hazard rate also affects the premium leg because once default occurs, the CDS ceases to exist and premium income would also cease.”
It doesn’t make sense to me. I thought increased hazard rate meant increased credit spread. If this were the case, why would the CDS seller (protection leg side) benefit from this? Can someone help me understand?
Thank you in advance!
It doesn’t say that the CDS seller will benefit. It says just the opposite: that the expected payoff is higher and that the expected premia are lower.
Hi, thank you for the comment.
I jumped too quick to the conclusion. Thank you.
To summarize: if the hazard rate goes up, the CDS seller is hurt by the increased credit spread (now faced with greater payoff to the CDS buyer), and the CDS buyer will also be affected simply because upon default, the CDS stops.
But the above is solely based on the occurrence of a default. If default does not occur, it should not affect either sides?