Skip to content

Well, sorta and maybe

The bank’s credit default swaps, which investors buy to protect themselves from a company defaulting on their debts, surged to a new record high as speculation swirled that it could be forced into a bailout.

Not wholly and exactly true.

The Credit default swap market is highly liquid and often cheap to trade. Certain bellwether issues don’t in fact trade upon actual evaluations of credit issues. Rather, upon speculative sentiment.

OK, so that should be speculative sentiment about credit issues but life gets more complex than that. What does everyone else think about credit issues?

For example, imagine you thought that the banking system was looking a bit fragile. You want to be able to bet – make money off – the idea that banks are going to be worth less. The CDS of a major like Credit Suisse is a great place to go take a bear position.

Yes, some of it will be speculation that CS itself will stop paying on its bonds. Don’t know whether it’s got contingent capital bonds or not but if they do they’d be hit hardest, obviously. But some of this is just going to be that we’ve a herd movement here and the CS CDS is a highly liquid market in which you can place a bear position.

The point of this being that we shouldn’t take the full change in the CDS as being the full estimation of the default possibility. Simply because some are using the instrument for a different speculative purpose. Information loops and all that…..

Leave a Reply

Your email address will not be published. Required fields are marked *