Technische Universität München Credit as an Asset Class - risklab

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CHAPTER 2. CREDIT RISK TRANSFER Figure 2.3: Global credit derivatives market (in USD billions, excluding asset swaps) The credit derivatives market shows an impressing growth. Its size is still small com- pared to other derivatives markets. Also in other respects, such as liquidity, transparency, standardisation and number of market participants, the credit derivatives market lags behind other derivatives markets. Credit derivatives, however, are the worldwide fastest growing derivative product and one of the fastest growing securities in the global securities market. 41 Market Participants Large commercial and investment banks, securities houses, insurance and re-insurance companies, financial guarantors, and hedge funds are the main market participants in the credit derivatives market. There are still some more participants who only contribute a small share to the overall market such as asset managers, high-net-worth individuals, special purpose vehicles (SPV) 42 , and other corporates. 43 The global banking industry still turns out to be a significant buyer of protection, with a net position 44 of USD 427 billion. Hence, this amount is transferred outside the banking industry to third parties, such as hedge funds and insurance companies. 45 Analysing the banking industry in more detail, we detect considerable regional dif- ferences. All reported regions acted as net protection buyers in 2004. European banks bought USD 294 billion of protection, North American banks and broker-dealers bought USD 123 billion, and Australian and Asian banks bought USD 10 billion. Within the 41 See [Bom05], p. 18, [BR04], p. 16, [Fit05], p. 11. 42 More information regarding SPVs can be found in Section 2.4.1. 43 See [Bri04], p. 5, [Fit05], pp. 1-3, [Bom05], p. 23, [BIS05a], pp. 22-23. 44 The net position is the difference between the amount that was gross sold and the amount that was gross bought. Thus, if the amount that was gross bought exceeds the amount that was gross sold, then the market participant is a net protection buyer, and vice versa. 45 See [Fit05], p. 1. 19
CHAPTER 2. CREDIT RISK TRANSFER European banks, Germany had by far the smallest net share with approximately USD 15 billion. In 2003, Germany even was a net protection seller. 46 There are smaller regional banks within the banking sector acting as protection sellers, since they consider credit derivatives as an alternative to enhance the yield on their capital, and they view them as an alternative or additional means of originating loans. 47 Insurance, re-insurance and financial guarantors mainly act as protection sellers. The overall net position amounts to USD 556 billion, thereof USD 319 billion taken over by the insurance sector. The insurance industry considers protection selling as profitable for several reasons: Corporate default is viewed as being nearly uncorrelated with the risks in their portfolio. Thus, by selling protection, both portfolio diversification and yield enhancement of capital can be achieved. Financial strength of insurance companies makes them appealing counterparties for institutions looking for protection buying, as counterparty risk is very small. 48 The difference of approximately USD 130 billion is held by market participants that are not covered by the survey, such as asset managers or hedge funds. 49 Hedge funds have emerged as players in the credit derivatives market for both protection buying and selling. They are estimated to have a share of approximately 25%-30% of the overall credit derivatives trading volume. Hedge funds have become more and more important to financial markets, as they contribute to reduce or even to eliminate mis- pricing of financial instruments by pursuing arbitrage opportunities. Probably the most important characteristic of hedge funds is their ability to inject significant liquidity into financial markets not only in periods of normal market conditions but also – particularly more important – in periods of stress. As they are largely exempted from regulation and able to easily implement investment strategies (often realised by taking short positions to a great extent), they can supply the market more easily and effectively with liquidity than other financial institutions. 50 Table 2.2 is taken from [Bri04] and it gives an overview on the market shares of main buyers and sellers of protection for 2003 and forecasts the shares for 2006. Protection Buyer 2003 2006e Banks 51% 43% Securities Houses 16% 15% Hedge Funds 16% 17% Protection Seller 2003 2006e Banks 38% 34% Insurance Companies 20% 21% Securities Houses 16% 14% Hedge Funds 15% 15% Table 2.2: Market shares of main protection buyers and sellers From the table, we can see a forecasted declining share of banks acting both as protection sellers and buyers. The other shares are forecasted to remain relatively stable. 46 See [Fit05], pp. 4-6, [Fit04], p. 4. 47 See [Fit05], p. 6, [Bom05], p. 24. 48 See [Fit05], p. 2,6, [Bom05], p. 24. 49 See [Fit05], p. 2. 50 See [Bri04], p. 5, [Fit05], p. 7, [Gre05], p. 5. 20
Page 1 and 2: Technische Universität München Ze
Page 3 and 4: Danksagungen Zuallererst möchte ic
Page 5 and 6: CONTENTS 3.8.2 Synthetic CDO (Synth
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epeat the adjusted formulas here in
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Chapter 6 Portfolio Selection After
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CHAPTER 6. PORTFOLIO SELECTION µ(x
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above definition of the VaR can als
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L� −∞ FR(r)dr = L� −∞ C
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Chapter 7 Simulation and Simulation
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CHAPTER 7. SIMULATION AND SIMULATIO
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CHAPTER 8. SUMMARY AND OUTLOOK fact
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Appendix A Mathematical Preliminari
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APPENDIX A. MATHEMATICAL PRELIMINAR
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APPENDIX A. MATHEMATICAL PRELIMINAR
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Appendix B Ratings Rating Descripti
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APPENDIX C. CALCULATION OF THE DYNA
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Appendix E List of Abbreviations AB
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BIBLIOGRAPHY [Das06] Das, S. (2006)
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BIBLIOGRAPHY [NS87] Nelson, C.R., S
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