You used spreads in your math as probabilities, I am just saying that is incorrect. The probability of default implied by the market certainly increases when spreads rise, without question. But, it is not a 1:1 relationship between basis points and %. Thats all I was suggesting. Also, do you think a move from 1 bp to 3 bp suggests that the market has decided that an entity is three times as likely to default? I suppose it is, but you are talking about infinitesimal numbers (of course, they could get bigger, as they did in agencies, who knows). But it could be the bid/ask spread. It is just a very very small base you are working on, it is the same sort of widening that you might see in a few minutes in a HY name (albeit we are talking UST here, so I know its a poor correlary).
MattLikesAnalysis Wrote:
——————————————————-
> If Rome can fall so can the US and the
> economic/political world didn’t disappear from
> Rome’s “default”.
>
Uh, yes it did. That’s what the Dark Ages were about. In 1300, the best road in Europe were the ones that the Romans built. Medical knowledge didn’t equal Roman medical knowledge until the 1500’s (at least). When Brunelleschi built his dome, he had to lfigure out how Romans built such structures more than 1000 years before. Worldwide growth was down for 1000 years.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Anyway, spreads increasing by a factor 2 doesn’t mean the probability of default increased by a factor of 2. It means that recovery value dropped, liquidity changed, default probability changed, etc.. Presumably CDS on Treasuries would pay off in any number of events beyond a complete repudiation of the debt (btw - gov’ts “default” on debt way more often than you might think through history. Recently was the Russian debacle but Latin American countries have been really close and through history you can identify hundreds of gov’ts that defaulted on domestic debt).
The US gov’t is solvent to the extent that taxpayers are willing and able to pay the debt burden. The US has just taken on the role of buying all kinds of crappy preferred stock in crappy companies. The debt is byond $10T and rising rapidly. Unemployment is coming and with this dropping tax revenues. Even Intel is having a tough time selling stuff. Suppose we go into a major depression with 30% unemployment along with average hourly wages dropping dramatically so tax revenues drop through the floor. Further, we acquire another $10T worth of debt “bailing out” industries that fail anyway.
The govt collects about $2T worth of taxes last year. If we have $20T worth of debt and a 40% drop in tax revenue that leaves us with $1.2T in tax revenue to service $20T worth of debt as well as run the rest of the govt. The $1.2T would be just barely enough to service the debt. Then the gov’t has a bunch of bad choices:
a) Raise taxes on the few who can still pay them (makes things worse).
b) Issue short-term debt at ever-increasing interest rates to make paymenst on long-term debt (and then just redeem short-term debt).
c) Literally print money (or electronically create it) to cover expenses. The classic road to hyperinflation.
d) Shut down gov’t functions at the times they are most needed.
e) Default on the debt by some restructuring or downright repudiation in which case the CDS pay off (the counterparty is posting collateral so the CDS might still be safe).
This is all very far-fetched, but I don’t think any of it is totally impossible. I’ll bet that Obama wouldn’t be re-elected if it happened.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Not for 1000 years, but it would surely be the end of an era of American pre-eminence. It would rock markets like nothing else ever has.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
There once was a man from Nantucket
Who borrowed money in buckets
And when I don’t pay
The banks will just say
We’ve got a bailout so [___] it.
Now enough poetry. No default on the National debt.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Even if the probability doesn’t change 1:1, The return comes in at 1:1 which is what really matters. Going from paying 2bps/yr to receiving 42bps/yr is a great return, thats all I really care about.
And I don’t believe a US default would be the end of capitalism, I can’t recall any ideology that wasn’t tested for millenias before it was disposed of. From what we know, capitalism will allow us to advance science faster than any other ideology we can think of. Now whether its up to us or not is another question.. rise of the communist states.. maybe, but communism is impossible unless all believe in it. I feel the west is going to become further fascist to control the state and that shall be our demise.
and I have to agree, JDV wins the post of the year award.
you are basically deriving the credit curve from the current par spreads. using this credit curve, you value your position based on the spread you locked in.
CDSW in bloomberg
Deleted User
I know how its calculated the problem is that the real probability of default is unknown by all market participants and formulating a probability of default for UST is almost impossible and can be off by 1 million st. deviations.
The probability is the result of the spread as it is the only indicator about how perceptions view default.
The bottom line is that, over the last year, should you have bought a CDS w/o the actual investment behind it, you would be up 14,200%, as you would have only paid $0.02/$100 for one year and would be able to lock in 9 years of $0.42/$100 as payment. Meaning an investment of $0.02 for a PVoa contract of $2.84 assuming a 5% rate.
I think I would be more inclined to sell this CDS than buy
Deleted User
ShouldBeWorking Wrote:
——————————————————-
> I don’t think you can actually calculate a PnL
> assuming it’s a riskless investment.
What’s the risk? I get paid out. I assign the annuity to a life corporation who then pays me a lump sum. I’m out of the trade and I’ve had no risk throughout the entire process. I’m protecting bonds I don’t own so I have nothing to lose except the premium I pay for that protection.
the life corporation will not give you the pv under the assumption that its risk free. they will calculate the unwind value using the JPM model
Deleted User
ShouldBeWorking Wrote:
——————————————————-
> the life corporation will not give you the pv
> under the assumption that its risk free. they
> will calculate the unwind value using the JPM
> model
But with the only risk being counterparty risk, using a cost of capital of 15% still provides a decent return. This has nothing to do with default UST at this piont, this has to do with default of the counterparties in the life co’s calculation of pvoa.
You used spreads in your math as probabilities, I am just saying that is incorrect. The probability of default implied by the market certainly increases when spreads rise, without question. But, it is not a 1:1 relationship between basis points and %. Thats all I was suggesting. Also, do you think a move from 1 bp to 3 bp suggests that the market has decided that an entity is three times as likely to default? I suppose it is, but you are talking about infinitesimal numbers (of course, they could get bigger, as they did in agencies, who knows). But it could be the bid/ask spread. It is just a very very small base you are working on, it is the same sort of widening that you might see in a few minutes in a HY name (albeit we are talking UST here, so I know its a poor correlary).
MattLikesAnalysis Wrote:
——————————————————-
> If Rome can fall so can the US and the
> economic/political world didn’t disappear from
> Rome’s “default”.
>
Uh, yes it did. That’s what the Dark Ages were about. In 1300, the best road in Europe were the ones that the Romans built. Medical knowledge didn’t equal Roman medical knowledge until the 1500’s (at least). When Brunelleschi built his dome, he had to lfigure out how Romans built such structures more than 1000 years before. Worldwide growth was down for 1000 years.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Anyway, spreads increasing by a factor 2 doesn’t mean the probability of default increased by a factor of 2. It means that recovery value dropped, liquidity changed, default probability changed, etc.. Presumably CDS on Treasuries would pay off in any number of events beyond a complete repudiation of the debt (btw - gov’ts “default” on debt way more often than you might think through history. Recently was the Russian debacle but Latin American countries have been really close and through history you can identify hundreds of gov’ts that defaulted on domestic debt).
The US gov’t is solvent to the extent that taxpayers are willing and able to pay the debt burden. The US has just taken on the role of buying all kinds of crappy preferred stock in crappy companies. The debt is byond $10T and rising rapidly. Unemployment is coming and with this dropping tax revenues. Even Intel is having a tough time selling stuff. Suppose we go into a major depression with 30% unemployment along with average hourly wages dropping dramatically so tax revenues drop through the floor. Further, we acquire another $10T worth of debt “bailing out” industries that fail anyway.
The govt collects about $2T worth of taxes last year. If we have $20T worth of debt and a 40% drop in tax revenue that leaves us with $1.2T in tax revenue to service $20T worth of debt as well as run the rest of the govt. The $1.2T would be just barely enough to service the debt. Then the gov’t has a bunch of bad choices:
a) Raise taxes on the few who can still pay them (makes things worse).
b) Issue short-term debt at ever-increasing interest rates to make paymenst on long-term debt (and then just redeem short-term debt).
c) Literally print money (or electronically create it) to cover expenses. The classic road to hyperinflation.
d) Shut down gov’t functions at the times they are most needed.
e) Default on the debt by some restructuring or downright repudiation in which case the CDS pay off (the counterparty is posting collateral so the CDS might still be safe).
This is all very far-fetched, but I don’t think any of it is totally impossible. I’ll bet that Obama wouldn’t be re-elected if it happened.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
I am by no means an expert in CDSs;
If I write a CDS on treasuries, how much $$$ would be required to initiate the contract?
What firms are still in the business?
Thanks!
You mean in your pa? You can’t.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
No. I was just interested in seeing what % would per required for X amount of protection.
Okay my question-
Would a US default = global dark age?
Not for 1000 years, but it would surely be the end of an era of American pre-eminence. It would rock markets like nothing else ever has.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Out of control capitalism ends in bankruptcy, that would be a poetic end to our era for sure.
There once was a man from Nantucket
Who borrowed money in buckets
And when I don’t pay
The banks will just say
We’ve got a bailout so [___] it.
Now enough poetry. No default on the National debt.
I’m Da Church of the faithful, I’m Liao Fengyi, clergywoman mother should have to introduce you to me, I have seen you twice, in which time you are more impressed with everyone I guess in the back of the church at noon to eat noodle face!
Dude that was art.
Best post ever
Even if the probability doesn’t change 1:1, The return comes in at 1:1 which is what really matters. Going from paying 2bps/yr to receiving 42bps/yr is a great return, thats all I really care about.
And I don’t believe a US default would be the end of capitalism, I can’t recall any ideology that wasn’t tested for millenias before it was disposed of. From what we know, capitalism will allow us to advance science faster than any other ideology we can think of. Now whether its up to us or not is another question.. rise of the communist states.. maybe, but communism is impossible unless all believe in it. I feel the west is going to become further fascist to control the state and that shall be our demise.
and I have to agree, JDV wins the post of the year award.
go to the link to see how the market prices CDS (start on slide 7)
http://www.yieldcurve.com/Mktresearch/files/Abukar_pptActualDec02.pdf
you are basically deriving the credit curve from the current par spreads. using this credit curve, you value your position based on the spread you locked in.
CDSW in bloomberg
I know how its calculated the problem is that the real probability of default is unknown by all market participants and formulating a probability of default for UST is almost impossible and can be off by 1 million st. deviations.
The probability is the result of the spread as it is the only indicator about how perceptions view default.
The bottom line is that, over the last year, should you have bought a CDS w/o the actual investment behind it, you would be up 14,200%, as you would have only paid $0.02/$100 for one year and would be able to lock in 9 years of $0.42/$100 as payment. Meaning an investment of $0.02 for a PVoa contract of $2.84 assuming a 5% rate.
I don’t think you can actually calculate a PnL assuming it’s a riskless investment.
I think I would be more inclined to sell this CDS than buy
ShouldBeWorking Wrote:
——————————————————-
> I don’t think you can actually calculate a PnL
> assuming it’s a riskless investment.
What’s the risk? I get paid out. I assign the annuity to a life corporation who then pays me a lump sum. I’m out of the trade and I’ve had no risk throughout the entire process. I’m protecting bonds I don’t own so I have nothing to lose except the premium I pay for that protection.
the life corporation will not give you the pv under the assumption that its risk free. they will calculate the unwind value using the JPM model
ShouldBeWorking Wrote:
——————————————————-
> the life corporation will not give you the pv
> under the assumption that its risk free. they
> will calculate the unwind value using the JPM
> model
But with the only risk being counterparty risk, using a cost of capital of 15% still provides a decent return. This has nothing to do with default UST at this piont, this has to do with default of the counterparties in the life co’s calculation of pvoa.
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