Using Credit Default Swaps to Price Intercompany Loan Guarantees

Thu Nov 20 20:24:38 UTC 2008
By Dr. Harlow Higinbotham and Dr. Stuart Harshbarger

In this NERA brief, Senior Vice President Dr. Harlow Higinbotham and Vice President Dr. Stuart Harshbarger examine five approaches currently being used to calculate arm's length intercompany loan guarantee fees for transfer pricing compliance and planning. The authors argue that a sixth approach, credit default swaps (CDS), are ripe for use as a "direct" method that has the potential to become the method of choice due to ease of application and ready availability of accessible third-party data. They demonstrate that use of CDSs has many advantages over the other five methods currently in use: the data are readily available and voluminous, the contracts are arm's length by definition, searches can be done quickly and efficiently after search parameters are established, and the comparables sets can be easily updated each year and/or indexed.