Saturday, July 24, 2010

credit risk analytics important to trading desks?

Now I realize the entire credit business (all those credit desks) in any trading firm operates around credit risk or "default risk" of individual issuing companies. I guess credit risk is at the center of all the securitization, CDS trading and straight buying ans selling of corporate bonds.

Am still unsure how precise a mathematician can be about calculating, predicting, measuring default probability. They probably take in tons of reported company financial data and feed them into some complex model.

Muni bonds have non-zero credit risk. In fact many muni bonds are below AAA rating. However, I don't hear about credit risk analytics in the muni business. In fact, one high yield muni trader I know always prices his offers by hand, without any automatic calculation.

High yield means low rating, right? So credit risk is higher and should be factored into the pricing logic. The trader seems to go by gut feelings?

Q: I know credit risk modeling is used in consumer and corporate loan pricing, but is it also used in fixed income trading? In such areas as interest rate swap, credit default swap, corporate bond trading?
A (from a practitioner): yes

Q: people tell me market risk and credit risk are 2 main focus areas for any bank, but if a bank holds lots of credit instruments (high yield bonds, IRS, CDS securities...) then i feel market risk measurement must depend on credit risk measurement. Right?
A (from a practitioner): yes

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