The spread that is attributed to the credit risk associated with a defaultable instrument (e.g., a credit default swap or a defaultable bond) over a risk-free instrument (risk-free bond). Generally speaking, this spread represents the yield spread between securities with the same currency and maturity structure but with different credit risks. The spread is often expressed in relation to a corresponding benchmark or deemed risk-free rate, in which case it constitutes the spread required by the market to take on a lower credit quality:
Credit default spread = interest rate on a defaultable instrument – risk-free rate
Or
Credit default spread= interest rate on a higher credit quality – interest rate on a lower credit quality
This spread reflects the market pricing of the underlying credit risk over and above the rate that involves no such credit risk. Its main determinant is the riskiness of an issuer.
It is also known as a credit risk spread or a credit spread.
