CDS Spreads and Default Risk -Interpreting the Signals Fitch Report
October 12, 2010--Summary
Credit default swap (CDS) spreads, along with other market-based indicators such as bond and equity price information, have become prevalent tools for risk analysis. CDS spreads are updated frequently (e.g., daily) and reflect a market view on a credit, attributes which are potentially useful to the valuation of trading exposures, active portfolio management, and the assessment of funding conditions.
CDS spreads are also sometimes used in deriving estimates of a company’s default risk and, in turn, the calculation of regulatory and economic capital. When used in this context, it is important to note that CDS pricing can be driven by a number of factors not directly related to an entity’s fundamental creditworthiness, such as the leverage inherent in CDS trading, liquidity conditions, counterparty risk, and the risk aversion of market participants.
This study analyzes how CDS market volatility and directional momentum in spreads can affect their performance as indicators of default risk during a stress period. The research sample includes five U.S. sectors that experienced pronounced spread volatility during the crisis and encompasses more than 100 actively referenced entities (see the Appendix for full list of companies). Although the focus is on these five sectors, the study’s findings have broader applicability to the performance of spreads as default risk indicators in other sectors and regions (e.g., Europe).
Fitch’s research indicates that overall performance of CDS spreads during the crisis period has been mixed. For example, spreads on property-sensitive sectors started to widen rapidly during the latter part of 2007 (see graph below). Widening spreads proved to lead the severe distress that occurred among monolines, but generated false positives for homebuilders and real estate investment trusts (REITs), sectors that as a whole experienced relatively mild erosion in credit fundamentals.
Source: Fitch Ratings
FESE September Newsletter
October 12, 2010--The September FESE Newsletter is now available.
Source: FESE
New World Bank Survey: New Business Registration Dropped amid Global Financial Crisis
October 12, 2010-- New business registration dropped sharply in richer countries amid the global financial crisis, but didn’t change much in many lower-income countries, according to a new World Bank survey released today.
The trend in 2008-2009 was driven by the global financial crisis, which began in developed countries and hit them harder, according to The 2010 World Bank Group Entrepreneurship Snapshots. By contrast, new business registrations in many low-income countries, which were not as affected by the crisis, held up. That’s mainly because those countries tend to have lower rates of new business creation to begin with, and economic shocks there tend to bring smaller changes. It helped that some countries recently introduced new measures to modernize business registration.
“We are providing the first evidence that the recent financial crisis has caused a quick and sharp drop in the number of new registrations of limited-liability firms,” says Leora F. Klapper, who co-authored the report with Inessa Love, both senior economists at the World Bank’s Development Research Group. “The findings also suggest that more dynamic business registration occurs in countries that provide entrepreneurs with reduced red tape and a stable investment climate.”
Source: World Bank
From Stimulus to Consolidation: Revenue and Expenditure Policies in Advanced and Emerging Economies
October 12, 2010-Preface
An extraordinary global effort on fiscal and monetary policy has been
required to support economic activity in the wake of the Great Recession.
A key challenge now facing the world economy is to ensure that economic
growth resumes in a strong, sustained, and balanced way. As the recovery
becomes entrenched, policymakers will need to start reducing public debt
ratios to more prudent levels.
This paper by the Fiscal Affairs Department (FAD) aims to assist International Monetary Fund (IMF) member countries in this endeavor by providing a strategy for fiscal adjustment that can help support sustainable growth over the longer term. It was presented at an IMF Executive Board seminar in May 2010. It discusses a menu of specific revenue and spending policy measures that could be considered to implement this strategy. On the spending side, the paper suggests a two-pronged strategy focused on stabilizing pension and public health spending ratios to GDP and reducing other outlays, including public wages, untargeted social spending, and subsidies. On the revenue side, particular attention is given to measures that could raise revenues by reducing existing distortions in the tax system.
Source: IMF
OECD composite leading indicator shows stronger sign of peak in expansion
October 11, 2010--OECD composite leading indicators (CLIs) for August 2010 reinforce signals of slowing economic expansion already seen last month. The CLI for the OECD area decreased by 0.1 point in August 2010, marking the fourth month in a row that the index has shown negligible or negative growth.
The outlook given by the CLIs for Canada, France, Italy, the United Kingdom, Brazil, China and India points strongly to a downturn. Stronger signals of a peak are emerging in the United States. For Germany, Japan and Russia the CLI points to a continuation of the expansion phase.
Source: OECD
Blow to bank crisis plans
October 11, 2010--Regulators are struggling to create a global mechanism that could wind down a big financial institution without the disruption caused by Lehman Brothers’ collapse in 2008.
The US is due on Tuesday to propose its own so-called “resolution” regime that would allow officials to stabilise a big, distressed bank, sell off assets over time and force creditors to take a discount on the value of their debt, without taxpayer money or market disruption.
Source: FT.com
Fragmented markets gave HFT rationale, says Rolet
October 11, 2010-Algorithmic and high-frequency trading’s main purpose is not to provide liquidity to markets but to trade between fragmented markets, according to the chief executive of the London Stock Exchange.
The comments, by Xavier Rolet, came the same day that the LSE revealed that a new trading system installed for its Turquoise trading platform – partly to attract high-frequency traders – was the fastest trading system in the world, at 124 microseconds for a trade to be done.
They come as regulators are scrutinising the role of computer programmes known as algorithms to drive trading automatically in markets, as well as the role of high-frequency trading, which refers to certain trading startegies that often use algorithms to get trades done at high speed
Source: FT.com
Study highlights CDS shortcomings
October 11, 2010-Financial derivatives that are widely tracked as a measure of creditworthiness of companies and countries have in many cases been poor indicators of default in the financial crisis, says Fitch Ratings.
The findings of the Fitch study highlight how privately-traded credit default swaps, where even the most actively traded contracts change hands only a few times per day, are influenced by many factors beyond the fundamental credit positions of companies or countries concerned.
Source: FT.com
Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material
October 8, 2010--Foreword
At their September 2009 Pittsburgh Summit, G20 Leaders requested the International
Monetary Fund to prepare a report on how the financial sector could make a ‘fair and substantial contribution’ to meeting the costs associated with government interventions to
repair it. In response, a talented team of Fund experts was assembled, recognizing both the
topic’s importance and the analytical challenge it posed. The question of how best to reconfigure the tax system to serve this purpose – while aligning it with a regulatory regime
that itself is under significant reforms – goes to the core of the difficulties faced in dealing
with financial system failures.
Surprisingly, previous academic work and policy debates provided very little guidance in this critical subject. Moreover, the issue was – and remains – both politically charged and highly controversial. This made the project one of the most difficult and fascinating that the IMF has undertaken in recent years.
The report that we delivered to the G20 Leaders Toronto Summit provided a concise summary of our analysis and views. Not surprisingly, policymakers’ reactions varied widely – in some countries, policies are being implemented along the lines suggested. In other cases, the proposals were met with strong objections.
view Financial Sector Taxation: The IMF’s Report to the G-20 and Background Material
Source: IMF
Growth Returning to Emerging Europe And Central Asia, But Concerns Center on Jobless Recovery
October 8, 2010?Economic growth has returned to the Emerging Europe and Central Asia (ECA) Region, but it has come with concerns about its jobless nature and doubts about its durability, according to the World Bank at a press briefing during the World Bank/IMF Annual Meetings 2010.
“The good news is that economic growth has returned to Emerging Europe and Central Asia, after the region suffered a sharp decline during the global economic crisis,” said Philippe Le Houérou, World Bank Vice President for the Europe and Central Asia Region. “Today, the region is back on the road to recovery. Thanks to stronger economies in Poland, Russia, and Turkey, growth went from a negative 5.1 percent dip in 2009 to a projected 3.9 percent growth in 2010.”
Source: World Bank