Default index not without its faults

   Date:2008/09/02     Source:
CREDIT-DEFAULT indexes that banks use to calculate writedowns from the subprime-mortgage market are probably poor indicators of future prices because they don't capture all debt instruments, the Bank for International Settlements said.

The Markit ABX.HE indexes "seem to have been widely used" by banks to hedge and trade as well as value subprime-mortgage-backed securities, BIS researchers Ingo Fender and Peter Hordahl wrote in a report yesterday. Such credit-default swap indexes only track a fraction of MBS instruments, they said.

"Observed ABX prices are unlikely to be good predictors of future default-related cashflow shortfalls on outstanding subprime MBS, especially for tranches at the higher end of the capital structure," the researchers wrote.

Securities backed by home loans to borrowers with poor credit histories have plunged, depleting financial firms of capital and squeezing global credit markets.

The world's largest banks and securities firms have reported more than US$513 billion of asset writedowns and credit losses since the start of 2007.

Credit-default swaps offer protection if the securities aren't repaid as expected, in return for regular insurance-like premiums.

The Switzerland-based BIS acts as a central bank for the world's monetary authorities.
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