3 ms·

What did you use as the recovery rate? Weird thing about the recovery rate is that everyone I've asked says the same thing, and I've traded CDS: the recovery r

What did you use as the recovery rate? Weird thing about the recovery rate is that everyone I've asked says the same thing, and I've traded CDS: the recovery rate is 40%. It's a bit of a free variable in that equation, and it matters. Trouble is how on earth do you estimate it? But random people I've met in the business will just say 40%, for every issuer, somehow.

oakwhiz 4y ago
Sounds like the financial version of dark matter
- lordnacho 4y ago
  A fudge factor that makes your models agree with observation? Yeah, pretty much. I was never an expert in CDS so I always wondered if other people had better ways of dealing with it. But nobody I've come across has ever offered anything other than 40%.
- WastingMyTime89 4y ago
  It’s not necessarily. A peculiarity of finance as a field of study is that a lot of the people studying finance only care about direct applications and a lot of the people teaching finance had this mindset when they learnt. It’s easy to end up with some poorly taught material. If you carefully looked at the model which gave rise to the equation you are considering, there probably is a very tangible meaning to the figure everyone is ball parking.
  - itronitron 4y ago
    >> there probably is a very tangible meaning to the figure everyone is ball parking 40 is awfully close to 42
- curiousgal 4y ago
  Not really. Quants modelled stochastic recovery rates and they saw that it doesn't really add much. Fixed recovery rates work just fine.
trillic 4y ago
Yup 40%, it's in the textbook, and as the other commenter nicely put it, it also seems like the financial equivalent of dark matter to me. We are living in times of idiosyncratic risk and my approximations above are likely no better than hearsay. That being said I'm not rushing to buy or sell $CS stock even with my elevated risk tolerance and the seemingly low price.
- 6stringmerc 4y ago
  I'm very interested in your term "idiosyncratic risk" having worked the Street and particularly fond of synthetics / swaps / GICs / etc. as a platform. My mental picture is a very unsteady hub and spoke like in Wipeout or something where the parties and counter parties are intertwined in ways that the dynamics are, as you put it, idiosyncratic.
- cuteboy19 4y ago
  What do you mean by idiosyncratic risk here? It seems as though you just read the word in an online forum where it was used in an context free manner. Read through investopedia.com/terms/i/idiosyncraticrisk.asp and tell me how it applies here?
  - jmillikin 4y ago
    It's a bit gutsy to ask someone who casually drops a CDS valuation formula into a conversation to justify themselves against an Investopedia article, as if a retail-oriented content farm is the definitive resource on finance. To answer your question, "idiosyncratic risk" in this context means that an individual company might have problems that don't broadly apply to the rest of its industry. For example Credit Suisse might have management that is bad at running a bank, leading to repeated investment losses and regulatory actions well beyond what's normal for big multinational banks. Look at the CS balance sheets over the past few years, or its stock price and PE ratio, or hell just Google "Credit Suisse books loss" and look at how many times they tried to stick their fingers in the wrong cookie jar. They got hit by the Hwang thing, they got hit by Greensill, and apparently they can't even accurately report how much money they're making (losing). I wouldn't want to have any position on their equity either.
acchow 4y ago
The recovery rate is written down in the terms of the swap. You'll have to read the contract.

oakwhiz 4y ago

Sounds like the financial version of dark matter

lordnacho 4y ago
A fudge factor that makes your models agree with observation? Yeah, pretty much. I was never an expert in CDS so I always wondered if other people had better ways of dealing with it. But nobody I've come across has ever offered anything other than 40%.
WastingMyTime89 4y ago
It’s not necessarily. A peculiarity of finance as a field of study is that a lot of the people studying finance only care about direct applications and a lot of the people teaching finance had this mindset when they learnt. It’s easy to end up with some poorly taught material. If you carefully looked at the model which gave rise to the equation you are considering, there probably is a very tangible meaning to the figure everyone is ball parking.
- itronitron 4y ago
  >> there probably is a very tangible meaning to the figure everyone is ball parking 40 is awfully close to 42
curiousgal 4y ago
Not really. Quants modelled stochastic recovery rates and they saw that it doesn't really add much. Fixed recovery rates work just fine.

trillic 4y ago

Yup 40%, it's in the textbook, and as the other commenter nicely put it, it also seems like the financial equivalent of dark matter to me. We are living in times of idiosyncratic risk and my approximations above are likely no better than hearsay. That being said I'm not rushing to buy or sell $CS stock even with my elevated risk tolerance and the seemingly low price.

6stringmerc 4y ago
I'm very interested in your term "idiosyncratic risk" having worked the Street and particularly fond of synthetics / swaps / GICs / etc. as a platform. My mental picture is a very unsteady hub and spoke like in Wipeout or something where the parties and counter parties are intertwined in ways that the dynamics are, as you put it, idiosyncratic.
cuteboy19 4y ago
What do you mean by idiosyncratic risk here? It seems as though you just read the word in an online forum where it was used in an context free manner. Read through investopedia.com/terms/i/idiosyncraticrisk.asp and tell me how it applies here?
- jmillikin 4y ago
  It's a bit gutsy to ask someone who casually drops a CDS valuation formula into a conversation to justify themselves against an Investopedia article, as if a retail-oriented content farm is the definitive resource on finance. To answer your question, "idiosyncratic risk" in this context means that an individual company might have problems that don't broadly apply to the rest of its industry. For example Credit Suisse might have management that is bad at running a bank, leading to repeated investment losses and regulatory actions well beyond what's normal for big multinational banks. Look at the CS balance sheets over the past few years, or its stock price and PE ratio, or hell just Google "Credit Suisse books loss" and look at how many times they tried to stick their fingers in the wrong cookie jar. They got hit by the Hwang thing, they got hit by Greensill, and apparently they can't even accurately report how much money they're making (losing). I wouldn't want to have any position on their equity either.

acchow 4y ago

The recovery rate is written down in the terms of the swap. You'll have to read the contract.