Valuation models: The value of number crunching
New valuation models have underscored the need for accurate mark-to-market pricing for credit derivatives.
Two new credit derivatives valuation models were launched last month, an illustration of the challenge investors face in accurately pricing the risk embedded in these instruments. But the two platforms approach the market in contrasting ways and are targeting very different types of investors. Rating agency Fitch Ratings has launched Risk Analytics Platform for Credit Derivatives (RAP CD), which aims to drive transparency in market risk for single-tranche synthetic CDOs. Data provider Markit Group is using its proprietary data to provide independent portfolio valuations across a range of vanilla and exotic OTC derivative instruments.
Kim Slawek, group managing director at Fitch Ratings, describes its new product as a natural evolution for the rating agency. But it marks a significant departure in that it focuses on market risk, not credit risk. “Mark-to-market risk and understanding volatility are the biggest barriers to investing in synthetic CDOs,” she says. “We want to bring as much transparency to the market risk side as we have to the credit risk side. There is a lot of market risk embedded in credit and this is a far more efficient way to get intelligence on the drivers for CDO pricing.”
RAP CD will produce a mark-to-model price and a market risk report, which will outline the drivers of the valuation and what is driving correlation.