Credit triangle
Quantitative Finance glossary · Quantitative Finance
Definition
Back-of-envelope approximation relating par CDS spread s, hazard rate h, and recovery rate R: s ≈ h,(1 - R). Holds exactly in continuous time with constant hazard and zero rates; in practice it is the first-pass inference of market-implied hazard from CDS quotes (e.g. s = 200 bps, R = 40% implies h ≈ 333 bps). For more accuracy: full piecewise-constant hazard bootstrap from the CDS curve.
Credit triangle in plain English
Imagine you lend money to a company and worry it might go bankrupt. Two things decide how risky that is: how *likely* it is to default each year (the "hazard rate" h), and how much you'd claw back if it did (the "recovery rate" R — so 1-R is what you actually lose). The credit triangle just says the yearly insurance premium to protect against that default, the "CDS spread" s, should roughly equal your chance of losing times how much you'd lose: s ≈ h,(1-R). It's a napkin-math shortcut — if insurance costs 200 basis points (that's 2%, since a basis point is one-hundredth of a percent) and you'd recover 40%, then the market thinks the default chance is about h ≈ 0.02 / 0.6 ≈ 3.3% a year. Traders use it for a fast first guess, then switch to a more careful calculation when precision matters.
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