Several years ago such terms as first-to-default baskets and default correlation trading were terms understood and used by only a handful of bankers, hedge funds and inter-dealer brokers. Now first-to-default baskets have been standardised and every bank is publishing research on measuring and pricing default correlation.
The original credit derivatives – credit default swaps and collateralised debt obligations – have made possible the creation of standardised tradable baskets that have in turn brought the idea of credit derivatives to the market proper.
These foundation stones have allowed banks and others to create the kind of derivatives in credit that have long been the mainstay of the equity market. Indeed while options on indices and single-name credit default swaps are still a rarity, the market is growing and such exotic ideas as exchange-traded futures are predicted to be launching shortly.
In the ABC of CDOs, our previous guide in the ABC series, I mentioned that it was difficult to see the market continuing to innovate and develop in the next five years as it has in the past five. Since those words were written, they have begun to be undermined and what is today considered ‘exotic structured credit’ will in five years be considered as normal as the credit default swap and collateralised debt obligation are today.