Credit data vendors focus on liquidity metrics

Vendors and their clients are focusing on the implementation of liquidity analytics to boost credit risk management

Liquidity analytics are becoming increasingly important to the process of risk management and for understanding price formation in the credit markets, according to credit data providers with liquidity management tools.

In a whitepaper due to be released this week by CME Group's credit data vendor subsidiary Credit Market Analysis, Michal Koblas, senior quantitative analyst at CMA, stresses the importance of analyzing liquidity for risk management purposes, suggesting that certain liquidity indicators-such as the frequency with which market markers issue quotes in certain securities-can act as leading indicators to future movements in credit spreads.
The research studies patterns in quoting activity surrounding the demise of Lehman Brothers, and more recently the credit concerns over Greek sovereign debt, and uses CMA's Quoting Frequency indicator, which measures the frequency at which quotes for any given credit default swap are distributed, dating back to 2008, and-along with various other measures of liquidity, such as the number of firms quoting a particular security and the size of bid/offer spreads-serves as a proxy for liquidity.

In the whitepaper, Koblas concludes that changes in the frequency of quoting activity can occur "before a significant price shift" and should therefore be viewed as potential "early warning signals" that would allow investors to reassess the underlying issuer and adjust exposures "before potential issues escalate."

The research supports efforts underway at other vendors to provide more measures of liquidity. For example, rival credit and derivatives data vendor Markit is planning to expand the asset class coverage of a series of credit liquidity metrics originally announced in March. Markit made its liquidity metrics for CDSs and bonds available earlier this month, including indicators such as bid/offer spreads, market depth information and the type of pricing source, and aims to release similar metrics for loans and asset-backed securities over the coming months.

The liquidity metrics will be distributed on an ongoing basis, although the vendor is also considering whether to offer historical metrics based on previously collected data.

The availability of individual liquidity metrics varies depending on each asset class, but Markit aims to rate the liquidity of each security on a scale from one to five (with a score of one indicating the highest level of liquidity), calculated using a proprietary model that uses the vendor's liquidity metrics as inputs, says Charles Longden, managing director of fixed income at Markit. Clients will also be able to use the underlying metrics in their own models, Longden adds. However, he stresses that Markit's liquidity metrics are only measures of observable liquidity, and that while its scores can act as a good proxy for liquidity, they do not guarantee that liquidity will be available to execute trades.