What is the value of modified restructuring?
Alex Reyfman and Klaus Toft
Introduction
Credit derivatives: the past, the present and the future
The determinants of credit spread returns
What’s driving the default swap basis?
What is the value of modified restructuring?
The debt and equity linkage and the valuation of credit derivatives
Nth to default swaps and notes: all about default correlation
Portfolio credit risk models
Credit derivatives as an efficient way of transitioning to optimal portfolios
Overview of the CDO market
Synthetic securitisation and structured portfolio credit derivatives
Integrating credit derivatives and securitisation technology: the collateralised synthetic obligation
Considerations for dynamic and static, cash and synthetic collateralised debt obligations
CDOs of CDOs: art eating itself?
Valuation and risk analysis of synthetic collateralised debt obligations: a copula function approach
Extreme events and multi-name credit derivatives
Reduced-form models: curve construction and the pricing of credit swaps, options and hybrids
Dynamite dynamics
Modelling and hedging of default risk
ISDA’s role in the credit derivatives marketplace
Credit linked notes
Using guarantees and credit derivatives to reduce credit risk capital requirements under the New Basel Capital Accord
In this chapter, we present a framework for quantifying the value of modified restructuring (Mod R), modified modified restructuring (Mod Mod R), and old restructuring (Old R) in a credit default swap (CDS) contract, relative to a contract with only bankruptcy and failure to pay credit events (No R).11Under our base-case assumptions, for a five-year CDS contract, the value of Mod R is 1.9% of the No R spread, the value of Mod Mod R is 2.5%, and the value of Old R is 10.1%. We find that for reasonable parameter values, the model produces a Mod R premium of 1–6% of the No R spread for a five-year 100 basis points (bps) CDS, which is at odds with the current market premium of 5–10% at the time of writing. This suggests that market participants may be overpaying for the cheapest-to-deliver option in Mod R contracts.
The value of the restructuring credit event in a CDS contract depends upon:
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the contractual maturity restrictions on deliverable obligations;
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the term of the CDS contract;
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the capital structure of the reference entity; and
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the likelihood of the restructuring credit event relative to bankruptcy or failure to pay.
The Mod R CDS contract places the
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