Category: Efficient Markets

What determines the shape of the zero curve? Why is it sometimes downward sloping sometimes upward sloping and sometimes blogpartly upward sloping and sometimes partly downward sloping?

Lot of theories have been proposed but the simplest one is the expectation theory which conjectures that long-term interest rates should reflect the expected future short-term interest rates. More precisely, it argues that the forward interest rates corresponding to a certain future period is equal to the expected future zero interest rate for that period.  Continue reading


Equity markets (specifically the market for large capitalization stocks) seem to be very different from other markets in that they areblog the only markets that are unconditionally liquid. The Basel Committee has officially recognized this – in their classification of 24 markets by liquidity horizons, the large cap equity market is the only market in the most liquid bucket. (Basel Committee on Banking Supervision, Fundamental review of the trading book: A revised market risk framework, Second Consultative Document, October 2013, Table 2, page 16)

There is abundant anecdotal evidence for the greater liquidity of large cap equity markets in stressed conditions – you may not like the price but you would not have any occasion to complain about the volume. For example, in India when the fraud in Satyam was revealed, Continue reading

Off late most investors of below investment grade debt – be it leveraged loans or high yield bonds – are intently focused imageson three specific questions, two of which are fairly straight forward, while the third is more complex:

Q1. What is the state of the credit fundamentals and tangentially, what are current underwriting standards like?

A1. Solid and reasonable, respectively

Q2. What are valuations like in the market?

A2. The current and forecasted benign default environment is supportive of current valuations and spread levels; however, macro influences could lead to bouts of volatility Continue reading

There was a unique study done recently paper titled “MARKET EFFICIENCY AND DEFAULT RISK: EVIDENCE OF AN imagesANOMALY FROM THE CDS AND LOAN CDS MARKETS” by Lawrence Kryzanowski, Stylianos Perrakis and Rui Zhong.

The findings where significantly positive pricing-parity deviations from a simulated portfolio that simultaneously participates in opposite legs of the undervalued and overvalued contracts in the CDS and LCDS markets for exactly the same underlying firm, maturity, currency and restructure clauses. These deviations cannot be accounted for by trading costs, illiquidity or imperfect data about recovery rates in the event of default, suggesting segmentation between CDS and LCDS markets. Continue reading

The Bank of England has released two papers on CCPs, which explain lossallocation rules, and how to balance the costs Aof default resources with the expected losses.
Paper 19, titled: “Central counterparties and their financial resources—a numerical approach”, maintains that new regulatory standards have required central counterparties to have robust processes in place to mitigate their counterparty credit risk exposures.
“At the same time, the standards allow CCPs to tailor their risk management models. This paper considers how CCPs can optimally determine the relative mix of initial margin and default fund contributions in a stylised setting, by balancing the costs of default resources with the expected losses they protect against,” .  Continue reading

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