Credit Index Basis (Skew)

[Cheng]

Poly,



I had the fact in mind that you effectively can't hedge tranches with the index anymore. Since those are different assets you incur risk weighted assets on both positions even if your deltas, say, are offsetting. So I was wondering whether the same holds true for index vs single CDS. It's two different assets at the end of the day although you can reasonably replicate one with the other (except for the basis of course and as we have learned during 2008 this can cause a lot of headache).

[polysena]

frstwrldprblm



markit  at page 13, 7th bullet point you have another approach. Poly

[polysena]

Cheng



by "effectively" do you mean it in the sense of "effective hedging" in the accounting sense (which I understand only very vaguely)? 



You can hedge the way you want, however the regulatory capital framework in the case of correlation trading will impose on you the following rules:



1. Case A: you have no certified approaches for correlation trading, for banking book exposures and for fixed income positions in the TB: then you use the concentration ratio for your tranches and for the index a look-through approach based upon ratings of underlyings. your charge is the sum of long and shorts after offsetting what you can (see further).



2. Case B: you have no certified approach correlation trading, but you have a certified approach for banking book exposures, and for fixed income positions in the trading book (IRC).  Then your tranched positions can be treated under SFA, but here you could use the IRC model for your Index position. The charge would be the charge on the tranched position plus the IRC charge.



3. You have certified approach correlation trading CRM, but you have a certified approach for banking book exposures A- IRBA, and for fixed income positions in the trading book (IRC).  Then your hedges must be treated with your positions.



you would have a charge coming from the CRM model approach  and you would have another charge coming from the "8% floor" ( computed here as SFA on the tranche and  look-through approach for your index). Total charge would be  max of ( 12 weeks of the CRMs measurements, the last CRM measurement, and last measurement of the 8%Standardized charge (after offsetting what you can)))



where the 8% of the standardized charge would be here with no offset unless you can prove that the index replicates perfectly the mouvements of your tranche as in a TRS.



Now with your example of an index and single CDS then you could offset by looking through those CDS (L,S) that have the same reference issuer (think delivery set of a CDS) same currencies, and not too much maturity mismatch... where the charge would be max (Longs,shorts).. there are some rules for off-setting that could be met: ie 100% if you can replicate the functionning of a TRS.



 



I do not know whether that helps or clarify. Poly



 



your positions and your hedges must be treated together



for off-setting you will need to go through the motions - do the market values of your hedge