Tag Archives: wider

New analysis of impact on exotic forex pair trading with wider bid ask spread

I keep hearing about the concern of the spread between exotic forex pairs. I can definitely see this in exotic forex pairs which can impact your profit. We also need to understand the nuances of what impacts increase of the spread

Here is that Oanda live spread tool

https://web-services.oanda.com/forex-trading/markets/live

 

This is all part of my Analytics service

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Why do you think Credit Default Swaps are typically wider than Credit Spreads on the same Corporate Bonds?

Why do you think Credit Default Swaps are typically wider than Credit Spreads on the same Corporate Bonds?

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Although theoretically CDS spreads and corp bond credit spread are meant to be equal, this is based on a specific balance of types of traders in the market i.e. hedgers, speculators etc. However the recent credit crisis has seen the term structure of their risk profiles changing i.e. more risky investors have maintained their long term risk appetite, but their short to medium term risk appetite is less. This short to medium term is what defines the term for with the CDS provides protection, hence seeing a rise in demand for credit protection for that specific term. This rise in demand is pushed way above the theoretical (and perhaps average) level thus lifting the credit protection premium i.e. the CDS spread.

Although the market participants can sell out of these positions, they prefer to hold on to the bonds for a term longer than the CDS term for various reasons(matching and solvency requirements for life insurers and pension scheme, and more optimistic view on the bond after the CDS term for more aggressive investors)

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In efficient market with no friction and perfect competition CDS spread will be equal to corp bond credit spread.

 

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A change in credit spread affects the value of the bond, not the reverse. Thus, a bond not trading at par has no influence on a bond credit spread.

 

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IMHO change of spread (and, for that matter, yield) and change in price are two of the same thing, one doesn’t ’cause’ the other. Spread and yield are just ways to quote prices.

Regarding my previous comment on bond being traded away from par, it’s actually more subtle. See, for example, http://mysite.verizon.net/zhou257/CDSBasis.pdf

 

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Using your framework, it appears you are contradicting yourself. First, you are stating that differences in CDS vs bond spreads are due to bonds not trading at par (which I still advance does not hold water). Then, you are stating that change in spread and price are essentially the same thing (which is very defensible). But, you can’t have it both ways.

 

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I don’t see how I am trying to have it ‘both ways,’ as the two issues here are independent and unrelated. The ‘defensible’ point aside, let’s go back to your original question. Bond credit spread and CDS spread are not required to be equal, they happen to be close to one another for bonds trading near par. This statement does not involve any change or dynamics of price and spread.

 

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CDS contains a delivery option and hence there is basis compared to a single bond. Liquidity premiums may differ between the bonds and CDS also.

 

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Fixed rate bonds trading below par because of a change in interest rate suggests bondholders can only lose the lower market value of the bond due to a credit default. Meanwhile, the CDS seller is still on the hook for the par value of the bond. In that case, the CDS spread would have to be greater than the bond spread to compensate for that greater risk. When a bond trades below par the inverse is true. Had you articulated this concept, I would have agreed with you outright.

On a positive note, thanks for sharing the paper on this subject. I am currently studying two other papers on that stuff. And, as soon as I am done I will study yours. Thanks again for sharing.

By the same token, I have found now so much info on the subject that this discussion is now mute. I wish there was a way to close such discussions. Given that, I invite you all to move on to other discussions and contribute where your help is needed. It is not here anymore. Thanks for your earlier contributions.

 

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NOTE I now post my TRADING ALERTS into my personal FACEBOOK ACCOUNT and TWITTER. Don't worry as I don't post stupid cat videos or what I eat!