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egumon
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Posts: 8
Joined: July 22nd, 2008, 6:20 pm

CDS Indices

March 10th, 2009, 11:36 pm

Hi All,

I noticed that whenever I pull up a single-name CDS on bloomberg it fills in the par spread curve with a full term structure, but whenever I pull up an index like CDX IG it just gives me a flat curve. Does anybody know if this is a market convention? I've always used the full term structure (from Markit) to price these.

Thanks
eds

 
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Ziggy
Posts: 149
Joined: January 27th, 2002, 10:59 pm

CDS Indices

March 11th, 2009, 1:41 am

The market convention is indeed to price the index of flat term-structure curve equal to the quoted spread for that maturity. This doesn't cause any arbitrage as the Index CDS is fixed coupon and always settled upfront (i.e. the PV of paying the standard coupon and receive expected losses). Settling the index of a full term-structure would make every trade a pain as both counterparties would have to agree on every pricing point on the term-structure.

The quoted index spread is therefore not the actual par spread unless the curve is flat. However it is relatively easy to calculate the par spread by bootstrapping into it, using the index upfront payment as a PV of a fixed rate CDS. Most CDS traders don't have to go to such lengths and are happy looking at the quoted levels in a relatively simple fashion. Correlation desks are more likely to go for a full bootstrapping as the exact term-structure of hazard rate is more meaningful for risk managing exotic products. At least that used to be the case, maybe now it's all about counterparty risk and trying to figure out what is the fundamental value of anything

Best regards,
Z
 
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egumon
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Posts: 8
Joined: July 22nd, 2008, 6:20 pm

CDS Indices

March 12th, 2009, 8:29 pm

Thanks Z. I guess this convention makes it simpler to trade. I suppose most people look for arbitrage between the index and it's underlier's rather than across maturities, although I suppose one could concoct some (statistical) arbitrage trade using different maturity single-name and index swaps. With fair spread bases (index 'skews') so out of whack now maybe it could even be profitable! I found a nice paper from RiskMetrics by Fabien Couderc that talks about some of this stuff (search his name + RiskMetrics; it's the second link).
 
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figoliuxi
Posts: 25
Joined: August 23rd, 2011, 4:05 am

Re: CDS Indices

August 10th, 2017, 6:11 pm

Ziggy wrote:
The market convention is indeed to price  the index of flat term-structure curve equal to the quoted spread for that maturity.   This doesn't cause any arbitrage as the Index CDS is fixed coupon and always settled upfront (i.e. the PV of paying the standard coupon and receive expected losses).   Settling the index of a full term-structure would make every trade a pain as both counterparties would have to agree on every pricing point on the term-structure.The quoted index spread is therefore not the actual par spread unless the curve is flat.  However it is relatively easy to calculate the par spread by bootstrapping into it,   using the index upfront payment as a PV of a fixed rate CDS.   Most CDS traders don't have to go to such lengths and are happy looking at the quoted levels in a relatively simple fashion.   Correlation desks are more likely to go for a full bootstrapping as the exact term-structure of hazard rate is more meaningful for risk managing exotic products.    At least that used to be the case, maybe now it's all about counterparty risk and trying to figure out what is the fundamental value of anything Best regards,Z

Bring up this topic again. I think using flat curve to value CDX would be enough. However, what about CDX option. To get the forward cdx spread, would it better use full term-structure or flat curve is good enough as well? Really would like to see what people trade in the market is doing.
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