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Wednesday, April 08, 2009


investment grade mispricing?

it's hard to tell whether this is a mere news cycle blip or the underpinning of a game-changing realization, but -- via clusterstock and CNBC's rick santelli -- a newly released draft of a paper penned by harvard's joshua coval and erik stafford as well as princeton's jakub jurek finds that current market pricing of securitized loans is not in fact a liquidity-driven mispricing of actual discounted cash flows but in fact a correction of previous mispricing of same.

"the pricing of investment grade credit risk in the financial crisis", abstract:

This paper uses a structural model to investigate the pricing of investment grade credit risk during the financial crisis. Our analysis suggests that the dramatic recent widening of credit spreads is highly consistent with the decline in the equity market, the increase in its long-term volatility, and an improved investor appreciation of the risk sembedded in structured products. In contrast to the main argument in favor of using government funds to help purchase structured credit securities, we find little evidence that suggests these markets are experiencing fire sales.

the focus is notably on investment-grade corporates, the better to avoid the problem is systemic misrating. if i read it correctly, the jist is to establish a link between equity and index option market perceptions and credit perceptions of modeled corporate cash flows, then evaluating any change in the balance. the conclusion is not that there is no mispricing, but rather that if the credit markets are mispriced they are no less so than equity markets.

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