BofA develops new credit risk model

Bank of America is developing a sophisticated model that uses derivatives data to help asset managers get a better handle on credit risk within their portfolios.

Aware of growing credit risk concerns among investors, the US bank has tentative plans to roll out its credit option-adjusted model of relative value in December, Raja Visweswaran, London-based head of European credit strategy and international credit research at Bank of America, told RiskNews.

A model that allows more sophisticated analysis on a portfolio-wide basis is expected to follow in the first quarter of next year. BofA will make its credit risk analytics available via the internet, so users can upload their own portfolio compositions into the model.

Bank of America’s model appears to be similar to other services, such as Credit Suisse First Boston’s (CSFB) modified Merton-type model, dubbed credit underlying securities pricing (Cusp). The CSFB model uses implied volatility from equity options markets.

But BofA claims its model is superior to others, as, in addition to using input data from equity and equity options markets, it also uses data from the bond market and credit default swaps market, Visweswaran said.

Questioned on how BofA’s model assessed the impact of the systemic credit risk represented by marked swap spread widening during the past 10 days – spreads for 10-year US swaps have been trading beyond 60 basis points, partly due to a JP Morgan Chase earnings warning two weeks back – Visweswaran said it was too early a stage in the model’s development for BofA to be definitive about how closely the current credit risk premium in credit markets reflects a sense of fear, unjustified by reality.

Two of those helping to develop the new model at BofA were taken from CSFB three months ago. David Goldman, New York-based head of global markets group research at BofA, was formerly global head of credit strategy at CSFB. Jeffrey Rosenberg, New York-based head of credit strategy research at BofA, was previously part of Goldman’s team at CSFB.

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