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The Price of Restructuring: CDS Market vs. BIS

By Anonymous

Relating to my discussion yesterday of whether the BIS should reduce the penalty for excluding the "modified restructuring" (Mod-R) credit event from CDS contracts, which is currently a 40% reduction in capital relief, a friend at a dealer bank has informed me that the spread between contracts with Mod-R and contracts with no restructuring credit event (known as "No-R") is roughly 9 basis points.

In other words, the market value of CDS contracts with restructuring is around 8-10% higher than the market value of CDS contracts without restructuring as a credit event. The BIS, on the other hand, contends that contracts with restructuring are worth 40% more than contracts without restructuring. While CDS market pricing isn't perfect by any means, it still suggests that the penalty for excluding Mod-R should be significantly less than a 40% reduction in capital relief. The BIS was receptive to this argument after the Conseco/Argentina fiascos spawned Mod-R and Mod-Mod-R (the European version), even though it didn't ever actually reduce the capital charge for excluding restructuring, so it'll be interesting to see what the BIS ends up doing.

Full post as published by Economics of Contempt on January 14, 2009 (boomark / email).