Amicus

Settlement Auction for Lehman CDS: Surprises Behind

Also, DTC has released this important note about settlement:

www.dtcc.com/news/pres...

Settlement Auction for Lehman CDS: Surprises Behind

It is interesting, to note, also, that the bid-offer spread in the first part of the auction went way up, from the Fannie/Feddire to the Lehman auctions, from an average of circa 2% to one circa 20%.

One wonders if this isn't partly related to the $640,000 quasi-penalty Goldman paid in "adjustments" in the last round (the inside market quote size also was cut in half). If so, this might explain Barclay's bid at 8 that I wondered about aloud above.

Whidbey, I'm certainly not an expert, as some of my questions probably show.

At this time, it's not clear to me how or why the valuation of CDS would be affected by the success or failure of these auctions - don't we theoretically like the price of credit to the probability of default, not to potential recovery rates? Obviously, I need to hit the books.

As for the auction itself, I've been through MarkIt's Auction Primer, to the point that I think I understand the calculations, but not the rationals (except at the big picture level of trying to set a settlement price).

For instance, when I first looked it through, I thought that the approach for any one firm would be to try to "win" in the limit phase about the same face value that was indicated to create the 'open interest' in via the first phase.

In that vein, I'm not sure, right now, what it "means" to offer $141m, but then end up with "winning" bids for $670m. Client orders? Why wouldn't they be part of the initial request, so that the total 'open interest' was larger?

I'm sure there is a logical explanation and it's just too late a night for me to figure it out. G'nite and g'luck.

Settlement Auction for Lehman CDS: Surprises Behind

Michael, great write-up. Thanks!

After looking over the Freddie/Fannie anomaly and reading through this, I have an alternative conjecture for your thesis about the "split result" in the last auction, in which the stop in one part of that auction trailed out at 99-something.

Could it be that the derivatives people participating in these auctions are simply ... not as skilled and used to running them as are, say, the primary dealers' desk?

While not inconsistent, per se, they look ... incomplete, in a technical sense of the term. I mean, look at Barclay's bids. Under what theory would bids peter out with *declining* price? Ditto Merrill Lynch. Compare that the Bank of America - their desk are willing to take the same amount of bonds at almost any price - with a bidding strategy like that, one imagines that ISDA should create a sidecar category for "non-compete" bids...

To be charitable, maybe it has to do with the structure of the auctions or the structure of the markets (can't treasury dealers go short in advance of auctions, in order to protect themselves?).

Last, keying off your insight about the impact that the net open interest might have on auction results, can we suggest that the reason that the reason the mid-market average came in below the pre-auction trading prices is that the net open interest was to sell bonds? Just under 60% of the satisfied limit orders were from three firms..

Last, I don't understand the Barclay's limit bids, in relation to the size of their physical settlement request. They put in a physical settlement request of $130m to buy, with a dealer bid at 8, then "won" $1,080m - almost 10x - with a weighted average bid of 9.47 in the limit order.