Comments on: CDS chart of the day, Portugal edition http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Sandrew http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21241 Tue, 23 Nov 2010 16:45:40 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21241 @tedtwong I meant only that the conceptual price of bearing credit risk can be reflected by a spread. You are correct that there is a relevant distinction between an up-front cash payment and a running spread. As greycap alluded to, the CDS market conventions changed last (dubbed the CDS “Big Bang”) s.t. single-name CDS ar now be quoted in a combination of up-front cash payment (points) and a standardized rolling spread (of either 100 or 500 bps, depending on the credit). Sorry if my explanation obfuscated rather than clarified.

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By: tedtwong http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21226 Tue, 23 Nov 2010 02:47:38 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21226 @Sandrew: “I think I mistook this as the price of the CDS instead of the yield on the CDS.” They are the same.

I don’t think they would be. Why would you sell me a 10 year CDS for less than a 5 yr one? If it’s a graph of price, that’s what the graph would be saying.

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By: xiaopengwu http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21219 Mon, 22 Nov 2010 23:34:19 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21219 How about the CDS charts of Spain, Italy, and France? Are they all like this one?

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By: Sandrew http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21216 Mon, 22 Nov 2010 22:35:47 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21216 @tedtwong: “I think I mistook this as the price of the CDS instead of the yield on the CDS.” They are the same. “Spread” is probably a better word than yield in this context. Risk-neutral default probabilities are typically derived from assuming a constant recovery rate (e.g. 40 cents on the dollar instantly upon default) and a piecewise flat term structure of hazard rates (instantaneous annualized rate of default, conditional on survival). A cheap (though inexact) calc for a hazard rate is CDSSpread/(1-RecoveryRate). The link between hazard rate and risk-neutral cumulative default probability at time T is simply [1-e^(-haz*T)].

@tonydd: “isn’t there a problem with the amount of potential liability and the means of insurers to compensate the insured?” Yes, and there’s even a name for it: counterparty risk, and it’s extensively studied and managed–which isn’t to suggest that it’s managed *well* by protection buyers, or sellers for that matter.

“Could those assets be liquidated for anywhere near the book value in a global sovreign debt melt down?” Good question. Again, there’s a name for that: wrong-way risk (see also: Armageddon insurance). But it may be worth asking whether a “global sovereign debt meltdown” is the *only* scenario in which a particular sovereign might default, and if so, whether, in such scenario, one’s CDS payoff would be the most important thing on one’s mind (or even anywhere near the top). This is why it is sometimes joked that CDS on the US treasury might more appropriately be denominated in (take your pick:) bullets/gasoline/spam/tinfoil (the latter for hat-making).

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By: Greycap http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21214 Mon, 22 Nov 2010 22:26:56 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21214 “I’m not sure I understand how to read the yield curve and get the implied probability.”

That is not easy to do. The qualitative shape of the curve is easy to read (Felix has already done so in the post), but backing out a hazard curve involves some assumptions and some calculation. I already mentioned recovery rate. In addition, you need to assume something about the form of the hazard curve, e.g. piecewise-flat, with the points at the quoted CDS tenors. Then at each successive tenor, you solve for the current additional piece of the hazard curve that makes the expected value of the credit event payment equal to the expected value of the swap coupons (plus the upfront amount, in the case of a standardized post-“big bang” quote.)

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By: tonydd http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21212 Mon, 22 Nov 2010 20:41:34 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21212 Excuse me as I am totally ignorant of this CDS stuff, but is’nt there a problem with the amount of potential liability and the means of insurers to compensate the insured?

And if this were not accurate then how are the insurers assets currently held? Could those assets be liquidated for anywhere near the book value in a global sovreign debt melt down?

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By: tedtwong http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21208 Mon, 22 Nov 2010 19:40:15 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21208 I’m not sure I understand how to read the yield curve and get the implied probability. If the yield is 3%, the risk-free rate is 1% and I’m a risk neutral investor, that tells me that the probability of default is [p(1.03)=1.01] — only around 2%. Am I reading this correctly?

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By: tedtwong http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21205 Mon, 22 Nov 2010 19:17:45 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21205 @greycap, I think I mistook this as the price of the CDS instead of the yield on the CDS. Thanks for the clarification.

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By: soja http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21204 Mon, 22 Nov 2010 19:09:01 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21204 greycap: given the yields on Eric Burroughs’ graph what would you calc today’s hazard rates on the 1Y, 2Y, 3Y, and 10Y Portugal CDS?

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By: Greycap http://blogs.reuters.com/felix-salmon/2010/11/22/cds-chart-of-the-day-portugal-edition/comment-page-1/#comment-21203 Mon, 22 Nov 2010 18:55:52 +0000 http://blogs.reuters.com/felix-salmon/?p=6259#comment-21203 Oops. Perhaps a definition is wanted. “Hazard rate” mans “probability of default given prior survival.”

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