What risks do the parties to a credit default swap give up and what risks do they take on?
In contrast to interest rate swaps but similar to options, the risks assumed in a credit default swap by the protection buyer and protection seller are not symmetrical. The protection buyer gives up the risk of default by the reference entity, and takes on the risk of simultaneous default by both the protection seller and the reference credit. By giving up reference entity credit risk, the buyer effectively gives up the opportunity to profit from exposure to the reference entity. The protection seller takes on the default risk of the reference entity, similar to the risk of a direct loan to the reference entity.
