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1、JEAN-MARTIN AUSSANTDIRECTORFIXED INCOME PRODUCT STRATEGY,PRMIALONDON18 MAY 2004,Recent market environmentNew market-implied techniques to manage credit risk Introduction to the BDP(Barra Default Probability)Practical ExamplesQuestions and answers(assuming I have the answers),Discussion Outline,Recen
2、t market environmentNew market-implied techniques to manage credit risk Introduction to the BDP(Barra Default Probability)Practical ExamplesQuestions and answers,Discussion Outline,Equity declines drove re-allocations to fixed incomeSimultaneously government yieldsdecreased to all time lowsCredit de
3、fault rates neared all time highsPension fund shortfalls(Focus on ALM)Credit markets are increasingly complexUniverse of assets is expanding rapidlySpread products are becoming more complicatedLimited headcount to cover expandingnumber of issues,Market Forces Change the Rules of Credit Investing,Cur
4、rently Very Few Easy Opportunities,End of the bear credit market in 2003Spreads have tightened to extreme levelsLowest since 1998Demand still highNon-traditional investors,Source:S&P,Outperformance Is More Demanding Than Ever,Are we being correctly compensated?Risk premium close to zeroHow does a lo
5、ng-only investor win/outperform?Spreads have nowhere to goMove toLower-quality/higher-yieldingFind names with value stillAsset selection is key,One Default Can Negate Entire Portfolios Return,Credit market is strongly asymmetricEarning the spread has become extremely difficult over the past few year
6、sUnprecedented market conditions with record downgrades and defaults,Source:Lehman Brothers,2002,Fundamental Analysis Alone Is Not Enough,Judgment of experienced analysts remains essentialHowever,judgment often impaired by questionable dataNearly 1000 accounting re-statementsin the last three years(
7、source:SEC)Creative accountingWhats required is a more efficient process to monitor,screen,and select credit-risky investments,Gaining the Advantage in Credit Investing,To successfully manage credit,you needEarlier,more accurate prediction of potential default risk Models that allow for the real-wor
8、ld uncertainty of financial statements Tools to make your credit analysis process more efficient,Recent market environmentNew market-implied techniques to manage credit risk Introduction to the BDP(Barra Default Probability)Practical ExamplesQuestions and answers,Discussion Outline,Market-Implied Me
9、asures Provide Additional Insight,Market-implied measures from the:Equity Market Barra Default Probabilities(BDP)Bond Market Barra Implied Ratings(BIR)Derivatives Market Credit Default Swaps(CDS)Coming soonCrossover Empirical Credit Risk(ECR)Equity Risk Implied Spreads(ERIS),Equity Market BDPs Go Be
10、yond Traditional Models,BDP advantagesIncomplete Information framework assumes fundamental data may be flawed Use of Barras industry standard equity volatility forecastEmpirical study of historical leverage,Barras model signals significant uptrend in default risk months earlier,Bond Market BIRs Lead
11、 Agency Ratings,Barra Implied Ratings take the bond markets perspective on credit and match it to a best fit distribution ofactual ratingsBarra ImpliedRatings typicallycan lead agency ratings by as much as three months,Barras measures provide earlier warning to possible downgrade,Derivatives Market
12、CDS Market a Leading Indicator,Credit Default Swap(CDS)rates often provide leading indication of risk and valueCDS market is exploding:more than$4 trillion notional outstanding andmost big names actively traded(source:BBA),Cash-CDS Basis HistoryMerrill Lynch(5 Year USD),Recent market environmentNew
13、market-implied techniques to manage credit risk Introduction to the BDP(Barra Default Probability)Practical ExamplesQuestions and answers,Discussion Outline,Current Quantitative Default Models,Structural or Cause-and-Effect approach(Merton)Default happens for a reasonFirm-specific information canbe
14、used advantageouslyReduced form approachDefault rates can be analysed statisticallyAd hoc,exogenously-given,default rate,Mertons Structural Model of Default,Default occurs at debt maturity if the firm valueis below the liabilities valueWe thus needA model of firm value processEstimate of default poi
15、ntMerton identified equity as being long a call option on the firm valueMerton identified a bond as being short a put option on the firm value,Payoff at maturity of the bond,Value of the Equity at maturity time T,Value of the Bond at maturity time T,i.e.default free bond+short European put on V K,Me
16、rtons Structural Model of Default,i.e.European call on V K,Mertons Structural Model of Default,0,D,V0,No Default,Probability of Default,Default,T,Reduced Form Models,Assume that default is totally unpredictableDefault comes unannouncedBased on a conditional default rate or intensityExogenously given
17、Fit well to market data including short credit spreadsAd hoc,lack intuitive appealThe picture:,?,Model Comparison,Based on a model definition of defaultIntuitive,appealingThe default time is often(implicitly)predictableHard to fit to empirical data,Based on an exogenously given default rateAd hocThe
18、 default time is always totally unpredictableEasy to fit to empirical data,Structural/Cause and Effect,What we want:a hybrid modelIncorporate the best features of structural and reduced formAvoid their pitfalls,Reduced Form,The Barra Default Probability(BDP)Model,A genuine hybrid of cause-and-effect
19、(structural)and reduced-form models(compensator approach)Based on a default time that is not predictableMakes use of all publicly available liabilitystatements and equity market dataAssumes investors have incomplete informationCalibrates easily to short credit spreadsIntuitive and appealing,Barra De
20、fault Probability Model Intuition,0,V0,T,Distribution of possible default boundary levels,Paths of Asset Value Process,Expected level of default barrier,Width represents uncertainty in the default barrier level,Time,Asset Value,Default Barrier Scaled Beta Distribution,Mean=current debt,Standard devi
21、ation,calibrated or user-configured,BDP Model Uncertainty Can Be Varied,Barra Default Probability Model,Variant 1,Variant 2,Variant 3,BDP Model A Firm Becomes Distressed,9/17/2001,9/10/2001,Credit term structure steepens and short-term spreads increase,BDP Model Subtlety Healthy Firm,4/15/2002,4/10/
22、2002,15%drop in equity,Credit term structure steepens but short-term spreads barely move,Testing the Model ROC Curves,Radar Operators in WWII:Plane(or flock of birds)?Medical Diagnosis:Is this persons Thyroid OK?Astronomy:Is this a Planet?Marketing Analysis:Will this household buy insurance?Credit R
23、isk:Will this name default?,ROC Curves Merton Comparison,Merton,BDP,Random Method,ROC Curves First Passage Comparison,First Pass,BDP,ROC Curves Moodys Rating Comparison,BDP,Moodys Rating,Recent market environmentNew market-implied techniques to manage credit risk Introduction to the BDP(Barra Defaul
24、t Probability)Practical ExamplesQuestions and answers,Discussion Outline,BIR Good Complement to Agency Ratings,ZOOM,ZOOM,BDP Outlier Identification,Inspecting like-credits in a new way can sometimes turn up opportunities or threats,USD BBB Consumer Cyclicals Average BDP=0.20%Toys R Us BDP=4.97%,Sour
25、ce:Barra Credit,BDP Warning of Toys R Us Downgrade?,Bond implied ratings moved in October as well,A few days later spreads widened,and months later Toys R Uswas downgraded to below investment grade(junk),Source:Barra Credit,BIR Mandate Restrictions,Early warnings of Potential Downgrades can allowman
26、agers to exit worrying names before the flood,The Bond Market was pricing in concerns back in Septemberwhen the Barra Implied Rating for Parmalat dropped to Sub-IG,Source:Barra Credit,BDP Early Warning,The equity market was also signalling concerns for Parmalat,The BDP moved well into HY levels befo
27、re December,Source:Barra Credit,Investment Grade(approximately),.,.,Capital Structure Arbitrage,Differing views from two markets on the capitalstructure point out interesting opportunities,FedExs announcement of its planned acquisitionof Kinkos triggered concern implied by the equitymarket but not r
28、eflected in bond spreads,Source:Barra Credit,Market-Implied Measures Offer More Insight,Source:Barra Credit,Research Papers and More Info,DatasheetsFlash DemosResearch PapersPractitioner PapersConference Attendance,jean-,MajpjMVcyzj21HLfrvy96dv02lPPfYgxUS7IYmZkyEmZ0kGeYZS3bpLCkYH1lt4EK7CxmUX3ijoYSOe
29、r7ZuaVWYgz4EpZrUirVpMzzvNtf1XZw5oswSXOtFaejnOcmfE1lZgnN1RSXg8wLCG8CVQ3XPJMvodPFWcpiYJgZazNSEPNIaklYSu7qSd1UpaxmZDlpN9zW7kljfsLCLi26Yv109ffbnDH8LbUN1G6ACURQ39eG12KHL9tXsZ1jzgoCK8g1kuNOh5eFvcmVT5ZYVQt9zk3rp3qLnf02FovEXxVRxjCcFRNppiJljNiOuk6fONnyX7fyGg7sXZ49BmCN5oy9VesHpKzdjTKwjrkCEQCFDehVmGax3lrOEbw63
30、VscA3YSijtUKoCyiLzAlVRp7l4QgPNHxvJFFDyjUVN3oHlMah0XBd4uTbkfPIhHtw0evPmYOrdhEDoPwvYhzlGplU1AU9mpyiCXH8gpPCBRYjq77VcnbXumNE1yGfyTsbSj89J63kRTKDkKUg3mdS5sJ4X5cQ8dK7oW9IkScssECQdz2O9UTlpRjAFPChjhLdzopQzwxQf8ozdzOhogwAooXpUF83BX4C3jRgjDJiiXEUDMaNz4vQ4n164vspddHvOIVuBBdMA4xp1YhiHk0vOJ8TL1BxogzVlMpmod6ianY
31、GmksQq6NWCEd56hZF4wfaNyZcrGfNxnPiG6ZAxSkfmhJAKtNmCqbRmppeXp8inz4eq3HkWCMSORyMMX522xpHG6basNr6KQfbZsFbHjzyNlJrruLolKFcC84dqfijBO5Dy2NaBcNEBPgQrT12PgpcKx2or2YChN5DPjs80zzdtdAdTKuW4uVv9bbZu3K2SZ2aEhTlIC1UqrIWibkzwHh6p8gLv26zr01mJybfOzFc4T7kQH1IpPwOzMDnAKPLsLrznXGjFNIA9bSWWms6ibKZwQIKrMzalwbFrQJvOP1rPH8rx2KkyYqrtQk5VRwM1HSX,
