How could markets have been so blind for so long? Credit markets appeared to have outsourced credit risk assessment the ratings agencies, who were asleep at the wheel, not to mention conflicted by lucrative subprime bond underwriting fees. Robert
■2006-1AAA’ Absolute Spread Levels
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Fig. 10 AAA CDO spreads. Source: Alan Laubsch (2009)
Schiller (having warned of housing bubble since 2005) attributed this collective denial to groupthink:
Suppose you imagine yoursel... Read More
In general, market liquidity can be defined as ability to trade when you want to trade (Harris 2002). To be more specific, a liquid market can be described as a market where participants can rapidly execute large-volume transactions with a small impact on prices (BIS 1999). Even the last definition is not precise enough, since it’s not clear what the following expressions mean: “rapidly execute”, “large – volume transactions” and “small impact”. In order to somehow evaluate such elusive characteristic of market quality, Kyle’s approach is usually applied in market microstructure research (Kyle 1985). Its key idea is to consider separately three different aspects of market liquidity: tightness, depth, and resiliency... Read More
It is an interesting question about what there would be on the market if there were no cancellations. Would trading or the market be stable or not? We realize the MF model without cancellations (we call it MFWC).
3 Model Upgrading
The most important thing that we try to improve in the MF model is the distribution of order price. We cut distribution into two parts: one with a positive tail and one with a negative tail. We find that both tails of distribution fit a good by power-law distribution with a tail exponent = —2.15 for positive values and a tail exponent = —2.493 for negative values (we inversed the negative tails and after that the estimate coefficients). Power-law poorly describes the center of distribution, when orders are put at the best prices... Read More
Abstract Bid-ask spread is a key measure of pricing efficiency in a microstructure framework. Today there is no universal model of spread formation that includes all three factors of transaction costs, inventory risk (losses in case of a changing value of a stored asset) and information asymmetry that influence the behaviour of traders and market-makers. Empirical evaluations of these three components of spread are very contradictory (Campbell et al., The econometrics of financial markets. University Press, Princeton, 1997; Easley and O’Hara, Microstructure and asset pricing. In: George MC, Milton H, Rene HS (eds) Handbook of the economics of finance. Elsevier, Amsterdam, pp 1022-1047, 2003)... Read More
StressGrades time series can help us visualize the interrelationship between risk themes. Figure 16 represents major stress themes using ETFs. Observe the sequential cascading of systemic risk starting with the February 27, 2007 equity outlier. In June an outlier drop in 10Y bond yields signaled deflation fear, and in August a jump in GLD signaled escalating inflation fears. Again, note the log scale for PStress.
Especially noteworthy is the increasingly synchronized increase in (Normal Implied) PStress observed across all asset classes after August 1, 2007 as systemic risk increased. Equally noteworthy is the synchronized decline in (Normal Implied) PStress in early 2009, signaling a systemic recovery.
StressQ is a snapshot of where volatility levels are currently compared to... Read More
According to the mortgage literature, the key determinants of default initially include observable socio-demographic characteristics, terms of the mortgage contract, mortgage characteristics, and macroeconomic conditions.
Terms of a credit contract are practically used as proxy variables to estimate the risk of a particular borrower. For example, mortgages with low loan-to value ratio (LTV) are attractive for non-liquid borrowers. The probability that they could face a serious problem of repayment of a loan is much higher. Moreover, borrowers with LTVs higher than 90 % think as holders, because they do not invest a lot of their own capital and are less motivated to overcome obstacles with repayment of a loan... Read More