Finely balanced books.
Notice the mark to market and the net = (positive fair value - negative fair value) in relation to notional amounts
In $ millions
*Market value of contracts that have a positive fair value.
**Market value of contracts that have a negative fair value.
End Q2-07. Source: OCC
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December 1st, 2007 at 5:09 am
Are these CDS valutions real ‘market value’ or ‘model value’?
Not to sound too geeky, but models on long-term options on Tsy bonds and the like work becaue of ‘pull to par’ — you knew the value of the underlying approached par as maturity approached. Every firm could use a different underlying stochastic process for interest rate — but in the end they all had to value the bond at 100 on maturity.
Surely, that relationship does not hold for options on corporate bonds (i. e,., CDS)?
December 1st, 2007 at 5:15 am
On other point, how much of the ‘matched’ nature of the CDS books of the bank is due to correlation assumptions? I’ve hedged by position in GM with a a correlation weighted basked trade?
As the option trader would say you are delta neutral until you aren’t.
December 1st, 2007 at 3:55 pm
“Are these CDS valutions real ‘market value’ or ‘model value’? ”
If there is a market, “market value” otherwise “model value”.Most single name CDS don’t trade much, the volume is on the big indices like iTraxx or CDX.
CDS models are very tricky because small changes in inputs change the price dramatically.So the banks will run a matched book and the model doesn’t matter because whatever model error there is on one side will be cancelled by the other [as long as the book is matched or close enough].With your GM trade or similar you will hedge with other CDS trades on the same name, same or different maturity but you want to keep the same default and recovery so that would exclude going for a basket or playing games with correlation.
If you look at the 1st picture the mtm are pretty closely matched especially given the size of the notional, so that suggests that they are matching overall.Basically you buy a CDS from A at x and you resell to B at some margin either same term or closely related on the curve.
December 2nd, 2007 at 2:29 pm
There’s where counterparty risk comes in play. Large banks may have balanced exposure, I’m not sure every other player has.