Gtarras

Buyer Beware: 30 Biggest Bankruptcy Risks

Made couple of spelling errors in previous post. Should read: CDS traders follow tens of companies.

Also, another comment. Technical issues sometimes amplify things. Look at MBI which is on the list. It sells insurance, and thus poses counterparty risk. So many folks who buy insurance from them, are forced to buy protection on MBI (buy CDS), which is fairly illiquid. They still buy it and drive CDS level up. So how much of liquidity premium is built into MBI CDS spread? Trust me, nobody knows.

Buyer Beware: 30 Biggest Bankruptcy Risks

I have spent plenty of time modeling CDS prices and working with CDS traders. While CDS prices do reflect probability of defaults, there are many things that I picked up along the way regarding pricing of these things:

1. Major driver in traders decision to buy/sell CDS is a direction of its price. Not default probability.

2. CDS, unlike bonds, have other covenants that can trigger an event, such as restructuring, moratorium etc.. even downgrade (sometimes).. So CDS reflects more things other than default.

3. CDS prices are driven by equity vol. You dont need to be a genius to know that these guys listed were most volatile. CDS traders usually follow ten of CDSs, do you think they have time to research them. I ALWAYS thought CDS trading was about momentum, not deep research. Also, for many names CDS could be very illiquid. Another thing: CDS levels that traders see on their screens are often not traded levels, but levels suggested by CDS models.

4. If you short equity, you max gain 100%. You buy CDS (similar to shorting a stock) your gain is unlimited. So CDS prices is a great speculative tool on the downside. You dont think hedgies abuse it?

In short, in today's environment, take CDS levels with a huge grain of slat.