9 ms·

The CDS market is pricing in an approximately 10% chance of $CS failing in the next year.

SeanAnderson 4y ago
I'm surprised it's only 10%. This morning was a very strong rally for beleaguered banking stocks and CS didn't budge an inch.
- bushbaba 4y ago
  Because credit Susie is “to big to fail” with the CDS likely pricing in the change of a government bail out
  - topper-123 4y ago
    Even if if doesn’t fail, the shareholderd might be wiped out though.
    - HDThoreaun 4y ago
      Shareholders being wiped out doesn't affect bond holders.
      - latchkey 4y ago
        What if bond holders are shareholders?
        rblatz 4y ago
        Their share value will be wiped out, and their bonds won’t be.
      - warbaker 4y ago
        Usually bondholders are also wiped out during a bailout. Bailouts are generally for customers / counterparties, not investors. Sometimes in a bankruptcy, bondholders take a "haircut" and agree to get less money back because the company simply can't pay them what they're owed.
alexpetralia 4y ago
Out of curiosity, how did you calculate this?
- a4a4a4a4 4y ago
  Not the person you're replying to, but you can calculate the "implied volatility" using the current option pricing vs the current stock price. As the consensus of price movement (up or down) increases, the option prices go up. https://www.optionsplaybook.com/options-introduction/what-is-volatility/ https://www.optionsplaybook.com/options-introduction/what-is...
- FormerBandmate 4y ago
  Credit default swaps pay the full value of a bond when a bond defaults, and pay nothing when it doesn’t. If a 1-year CDS is 10% of face value there’s a 10% chance of default in a year
  - mason55 4y ago
    I'm not a quant or banker but I don't think that's true. When a credit event is triggered, there's an auction for recovery of the defaulted bonds/loans, and then recovery is what's left from par. In addition, you have to take net present value of the settlement into account. Money compounds, it doesn't grow linearly. Let's say there's a 10% chance of a credit event in a year, a 0% chance today, and the chance grows linearly (27 bps/day). Even if the chance of a credit event grows linearly, and you hold the recovery rate steady, the net present value of the recovery amount grows as a function of e. All that to say, I don't think what you are saying is correct. See here for the correct formula: https://news.ycombinator.com/item?id=35154072 https://news.ycombinator.com/item?id=35154072
- trillic 4y ago
  Implied probability of default over a given time-span can be approximated with the equation P = 1 - ( e ^ ( ( -S * t ) / ( 1 - R ) ) where S is the CDS spread and R is the recovery rate. The spread can be solved using the inverse S = ln ( 1 - P ) * ( ( R - 1 ) / t ) Probabilities and rates are both expressed as percentages not basis points. S is the spread. t is years. R is the recovery rate. Source is my notes from undergrad. Options, Futures, and Other Derivatives (9th Edition) by John C. Hull. Take all this with a grain of salt as I am not a quant. (but I am looking for a job!) Doing some additional reading, there are some more precise approximations but they are less general.[1] Last number I was able to pull up the $CS CDS was trading at 551 BP. Up from 446 yesterday (an all-time high for $CS) Lehman Bros hit 640 BP just days before collapse. [1] https://quant.stackexchange.com/questions/15986/how-to-compute-the-implied-probability-of-default-from-a-cds-spread https://quant.stackexchange.com/questions/15986/how-to-compu...

I'm surprised it's only 10%. This morning was a very strong rally for beleaguered banking stocks and CS didn't budge an inch.

bushbaba 4y ago
Because credit Susie is “to big to fail” with the CDS likely pricing in the change of a government bail out
- topper-123 4y ago
  Even if if doesn’t fail, the shareholderd might be wiped out though.
  - HDThoreaun 4y ago
    Shareholders being wiped out doesn't affect bond holders.
    - latchkey 4y ago
      What if bond holders are shareholders?
      - rblatz 4y ago
        Their share value will be wiped out, and their bonds won’t be.
    - warbaker 4y ago
      Usually bondholders are also wiped out during a bailout. Bailouts are generally for customers / counterparties, not investors. Sometimes in a bankruptcy, bondholders take a "haircut" and agree to get less money back because the company simply can't pay them what they're owed.

alexpetralia 4y ago

Out of curiosity, how did you calculate this?

a4a4a4a4 4y ago
Not the person you're replying to, but you can calculate the "implied volatility" using the current option pricing vs the current stock price. As the consensus of price movement (up or down) increases, the option prices go up. https://www.optionsplaybook.com/options-introduction/what-is-volatility/ https://www.optionsplaybook.com/options-introduction/what-is...
FormerBandmate 4y ago
Credit default swaps pay the full value of a bond when a bond defaults, and pay nothing when it doesn’t. If a 1-year CDS is 10% of face value there’s a 10% chance of default in a year
- mason55 4y ago
  I'm not a quant or banker but I don't think that's true. When a credit event is triggered, there's an auction for recovery of the defaulted bonds/loans, and then recovery is what's left from par. In addition, you have to take net present value of the settlement into account. Money compounds, it doesn't grow linearly. Let's say there's a 10% chance of a credit event in a year, a 0% chance today, and the chance grows linearly (27 bps/day). Even if the chance of a credit event grows linearly, and you hold the recovery rate steady, the net present value of the recovery amount grows as a function of e. All that to say, I don't think what you are saying is correct. See here for the correct formula: https://news.ycombinator.com/item?id=35154072 https://news.ycombinator.com/item?id=35154072
trillic 4y ago
Implied probability of default over a given time-span can be approximated with the equation P = 1 - ( e ^ ( ( -S * t ) / ( 1 - R ) ) where S is the CDS spread and R is the recovery rate. The spread can be solved using the inverse S = ln ( 1 - P ) * ( ( R - 1 ) / t ) Probabilities and rates are both expressed as percentages not basis points. S is the spread. t is years. R is the recovery rate. Source is my notes from undergrad. Options, Futures, and Other Derivatives (9th Edition) by John C. Hull. Take all this with a grain of salt as I am not a quant. (but I am looking for a job!) Doing some additional reading, there are some more precise approximations but they are less general.[1] Last number I was able to pull up the $CS CDS was trading at 551 BP. Up from 446 yesterday (an all-time high for $CS) Lehman Bros hit 640 BP just days before collapse. [1] https://quant.stackexchange.com/questions/15986/how-to-compute-the-implied-probability-of-default-from-a-cds-spread https://quant.stackexchange.com/questions/15986/how-to-compu...