HSBC’s purchase of Household triggered credit rally, according to BoA
BoA used its model to assess the credit risk of an equally weighted portfolio composed of the top 30 issuers of investment-grade debt. In aggregate, the portfolio’s 5% tail risk was –3.71% - that is, there was a 5% probability of a loss in excess of 3.71%. Despite contributing just over 3% to cash proceeds, Household’s debt accounted for 10.1% of the tail risk – the largest single contribution to the portfolio’s tail risk.
Even though there may have been no change in risk appetite, HSBC’s takeover of Household effectively removed many investors’ exposure to a credit risky name. So credit investors’ subsequent push to buy credit risk elsewhere precipitated a widespread rally.
Last month, Raja Visweswaran, London-based head of European credit strategy and international credit research at BoA told RiskNews that the US bank plans to roll out its credit option-adjusted model of relative value in December.
BoA’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. The CSFB model uses implied volatility from equity options markets.
But BoA claimed 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.
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