Contents

Korean investors consider next move

Shift beyond managed synthetics possible

Synthetic CDO volumes in South Korea are growing rapidly. At present, investors are happy to focus on managed deals – but that could soon change.

Since the Korean regulator relaxed its rules on synthetic CDO investment 14 months ago, the country's major institutional investors – primarily banks and insurers – have been hoovering up all such products on offer that meet the regulation-stipulated minimum rating of double-A minus or above. From the beginning of this year, managed CDOs have been the investment of choice and deals from a range of well-known international managers – including Blackrock, KKR and PIMCO – have been printed in large sizes.

"There has been a pick up in interest from Korean investors in all types of credit derivatives to enhance yields, including the more simple structures such as first-to-default baskets, but the main theme this year is managed CDOs," notes one credit derivatives structurer.

He goes on to explain that, although dealers have done a considerable amount of promotion and education for all structured credit products in the last two or three years, investors' sophistication levels remain low by the standards of some other major financial centres. "More sophisticated investors might be able to closely examine 100-150 names before they buy into a CDO product, but for less sophisticated investors – which includes most of those in Korea – it is a very tough order for them to actually understand and know about these 150 names, which is where a manager can add a lot of value."

"It's not like we cannot buy static CDOs, but when you have a manager to actually manage the names for you to help avoid default risk it's actually easier for people who haven't bought structured credit products before and makes sense for them in particular to start looking into that," concurs one investor.

Consequently, there are understood to be a few more managed deals in the Korean pipeline. However, as investors gain more experience, the inherent cost of management fees is beginning to promote plans for a move into other kinds of deals.

"There have been some interesting private transactions using such things as CPPI technology, but for public issuance it's all been fairly straightforward CDOs so far. But that makes sense – people need to start to get comfortable with the new technologies in a particular product type, then they can look into other product types going forward," says the structurer.

That said, a small number of Korean investors have already started looking at self-managed CDOs, but remain stymied by the same issue as their more inexperienced peers – the need for understanding of international credit to enable them to effectively manage a global portfolio of names.

"If Korean firms want to offer the maximum value-added in a transaction, it would require a portfolio of pure Korean, or perhaps Asian, names. However, with that kind of composition, it is very difficult to come up with any structure that would make the product attractive enough for anyone to buy because Asian spreads tend to be tighter than global ones," the structurer concludes.

MP

Fear of the unknown

Investor transparency concerns continue

All the major dealers pay lip-service to improving structured credit market transparency. However, investors remain concerned about the reality beyond the safe harbour of vanilla instruments.

Undoubtedly some effort has been made towards improving transparency. As Dagmar Kent Kershaw, head of structured credit at Prudential M&G, observes: "Transparency has improved materially. For newcomers to the market it may seem as though pricing is opaque, but it has improved greatly compared to even a couple of years ago."

Nevertheless, there are still gaps between the prices banks give deals and the independent price necessary to mark-to-market the deal down the line. "There is much more information available to investors now, to enable them to understand pricing models better and create their own investment models. But on the synthetic side, from an investor's point of view, it is still difficult to compare relative value between bespoke, managed tranches. I don't think managers are necessarily the best people to price these deals on an ongoing basis, I see a natural conflict of interest there," says Kent Kershaw.

There are in fact concerns over far less complex structures than bespoke tranches. Not least in connection with dealer behaviour.

"Pricing transparency is always a concern in credit markets. In asset-backed CDS, this is made worse by the unwillingness of many market participants to disseminate meaningful colour on where trades occur. For example, the customary practice of providing 'covers' on cash auctions is almost non-existent in single name ABCDS," says Dean Smith, md and senior portfolio manager at Highland Financial Holdings Group.

In addition, investors say that dealers are still providing very wide bid-ask spreads in ABCDS - if they are willing to provide two-way markets at all. In fact, almost all "lower tier" players still seem to be in fear of getting picked off by the large dealers.

There are ways for investors to improve pricing transparency for themselves, however. Smith explains: "We make sure we know where the market is by maintaining an active dialogue with multiple dealers on both sides of the market; not falling in love with our biases, thereby retaining the ability to sell protection or to buy it on a fairly broad list of names as opportunities present themselves; being obsessive about capturing any reliable market colour that comes into our possession; and finally keeping a close watch on related markets, for example, home builders and CDOs."

JD

Independent investors

This week, Daniel Riediker, partner and ceo of Alegra Capital, answers SCI's questions

Daniel Riediker

Q: When, how and why did your firm become involved in the structured credit markets?
A: All four of Alegra Capital's partners were working for the same financial group – Centre Solutions, Zurich – and were involved in big ticket structured credit transactions, including securitisations. We had built up a good track record and saw the market potential in the securitisation space – we figured that what we had been able to do for one firm could be of interest to other investors. The growth in the market we expected to see would create significant demand for buy-side specialists. Therefore we decided to go on our own and established Alegra Capital more than three years ago. For over two years now, we have run a public fund with very satisfying results – no negative month since inception and an annualised net return of over 12%.

Q: In your view, what has been the most significant development in the European credit markets in recent years?
A: There have been two major developments from our perspective. First of all, the sheer increase in size of the credit markets and the fact that securitisation has gone to a whole new level. CLOs of leveraged loans are a good example – the market has grown from 1-3 deals a year in 2000 to over €16bn in issuance in 2005. Furthermore, in the first half of 2006 issuance has already matched the total 2005 numbers. Secondly, in step with the substantial growth in volume, we have seen liquidity and the professionalism of market players increase considerably.

Q: How has this affected your business?
A: On one side, more volume means more choice, which is very good. More liquidity and transparency is generally a desired development, but obviously certain opportunities that come along with illiquid markets no longer exist. More professional players in the market also means more stability in the long run. Nevertheless, the potential for short-term volatility driven by the more trading oriented players remains a factor. 

Q: What are your key areas of focus today?
A: We specialise in the management of subordinated tranches of securitisations, mainly CLOs of leveraged loans. We are completely independent from every investment bank. We do not issue our own CLOs, so we do not compete with any of the CLO managers; we honour confidentiality and yet we can do big tickets. Consequently, the market has accepted us as an independent and reliable player and we are able to do business with whichever counterparties we believe are most suitable for a given transaction. This approach has yielded good results for our clients and therefore for us as well.

Q: What is your strategy going forward?
A: We are an asset management company that has a no thrill theory – we know our strengths and we stick to what we do best. So we continue to invest in subordinated tranches of securitised products that are derived from attractive and stable underlying asset classes.

Q: What major developments do you expect from the market in the future?
A: There are a number of major shifts we anticipate:
      -          The European leveraged loan market will rise from its infancy and move away from a club-market to a more institutional market. We envisage that the arrival of credit derivatives will enable long/short strategies and add liquidity. With that, we expect that price differentiation will increase and specialised players, such as distressed managers, will have room for growth.
      -          Securitised markets will consolidate and become more standardised. This will put pressure on the fees of investment banks, rating agencies and also asset managers. This could be a couple of years away, but the trend is clearly visible.
      -          Some of the newer market participants have not yet seen a full credit cycle. With the kind of leverage deployed these days, it will be interesting to see how the market reacts to a down cycle.

About Alegra Capital
Alegra Capital is a Swiss company domiciled in Zurich. It is an independent asset manager solely dedicated to the management of asset-backed securities. Alegra Capital aims to create added value through superior ABS investment profiles. The analysis of credit portfolios and ABS structures is its core competence.
Over the last four years, the partners of Alegra Capital have invested in asset-backed transactions with an underlying loan portfolio in excess of €6bn. Alegra Capital is the asset manager of the Alegra ABS I (Euro) Fund.

MP

"The future is in structured products"

This week our Provider Profile is of broker GFI

Management guru Peter Drucker once said that business has only two functions: marketing and innovation. While some business managers might want to add a few more items to that list, it is undeniably true that if you market your successful innovations well enough, generally you will prosper. This certainly applies to inter-dealer broker GFI, when in the mid-90s it realised that the future of innovation in derivatives would be built on a small, fast growing, niche asset class called credit default swaps.

Mickey Gooch, founder of GFI, wanted to build his young firm on broking anything but plain vanilla, commoditised products. He couldn't see how to add value in this approach; other, older firms were 'burdened' with broking lower premium cash products for their long-term clients, and doing a good job. GFI saw that it could add to client value via the relatively new world of derivatives, and so its future was based (amongst other derivatives) on this exciting new asset class that offered a basic insurance solution for clients to hedge credit risk.

Steve McMillan

Investment banks are certainly making their competitive advantage work, with credit derivatives generating huge profits. GFI is happy to intermediate these deals, but as a good innovator, it is also looking forward to see how else it can get involved and facilitate the development of new products.

Brokers can only go so far in driving change; they are in the main reacting to rather than determining market sentiment, but they have a good vantage point from which to relate to experiences from elsewhere. "I would ask the credit derivatives market one big question," says McMillan. "The equity market doesn't have a distinct buy and sell side trading approach anymore. For instance, you can go to a bank, broker or exchange to buy and sell shares; in this respect barriers have been broken down. But the question is, can this happen in the credit market too? Maybe the trade sizes in credit will always remain too big for these barriers to completely break down; you can trade 100 shares worth £1000 in the retail market, but such small value trading will never happen in the bond markets."

For barriers to break down, markets must mature; if the market is to mature as quickly as GFI has experienced so far, new products will emerge. So, what is the next big product development that the firm expects? McMillan has a fair idea of how the market could evolve.

"What's interesting is how the banking community has developed credit risk management products so quickly. You can now hedge counterparty risk and define your parameters efficiently. The reinsurance markets could learn a great deal here. In credit you can get in and out of a trade comfortably. If, however, you've invested in a catastrophe bond from a reinsurer, linked for example to the hurricane season, and a disaster like (hurricane) Katrina hits, you cannot easily get out – there's relatively little liquidity. Once your money's on the table, it's difficult to just take it away when you want to, like you can with a credit default swap," he says.   

"I suspect banks are looking at the insurance market and considering how they can perform those risk management tasks more efficiently," continues McMillan. With the structuring costs on a catastrophe bond often exceeding the premium, he doesn't see this area as a product with huge growth potential for insurance firms.  

Structured credit, on the other hand, is seen by GFI as a key part of product development for banks. "Loan and asset-backed CDS are offering more hedging potential. We will see structured products increasingly being offering by banks to their clients. Correlation plays involving credit/equity, credit/commodity and credit/interest rate components all offer the basis for diversity. And we have clients with portfolios of risk dispersion and optionality that we are not yet fully servicing," confirms McMillan.

One of the biggest drivers of product growth is the yield-hungry hedge fund sector. "With the bigger hedge funds now looking like trading arms of banks, the challenge and the opportunity for investment banks is to offer this sector the diversity and yield enhancement it requires. This is why the future is in structured products of all types. Credit will form the basis, but the product set will widen as liquidity and commoditisation rises and yields inevitably fall," adds McMillan

Today, however, a more straight forward investment is needed to ensure that a demand exists for new products. The backlog of outstanding credit derivative trade confirmations currently being cleared up by banks is a crucial part of successful development; part of the total exposure that the banks face, claims McMillan.

He explains: "Electronic trading and straight-through processing is required as standard, to confirm and clear trades, if more of the buy-side is to be encouraged to trade (GFI is participating in Affirm Express - Depository Trust and Clearing Corporation's post-trade STP offering). We see a hybrid voice/electronic broking solution as being the right one in structured credit; we pioneered this approach in the late-90s. It combines the best aspects of these different ways of broking for this market."

There has been much talk of a futures contract on credit default swaps. So, is this the next natural development for the market? McMillan is unsure about how successful a futures contract will now be. "Maybe a futures contract on credit defaults has missed its time," he notes. "The indices are so wide and liquid, and have proven their risk management potential, that you wonder if the buy-side will embrace a futures contract now."

If, however, there is to be a futures contract, you can bet that GFI will be involved on behalf of its clients, right at the very beginning.

JW

Berichi to lead FSI's ABS CDO platform

The latest people and company moves

Berichi to lead FSI's ABS CDO platform
Investment advisor Financial Stocks, Inc (FSI) has hired Karim Berichi as director and head of ABS investments. Berichi, former head of US ABS investments at Fortis Investments, will lead FSI's ABS CDO platform.

Berichi will report to Steve Kuppenheimer, head of structured finance, and will work out of FSI's New York office. FSI says that Berichi's role is to pursue opportunities in the ABS CDO market including mezzanine and high grade strategies.

Steven Stein, chairman and ceo of FSI, and John Stein, president, will continue to oversee management of the firm and its core investment portfolios. FSI operates a multi-strategy investment platform focused on opportunities in the financial services sector. The firm specializes in financing and investing in banks, thrifts, insurance companies, REIT's, real estate operating companies, specialty finance firms, asset management firms, financial technology companies, and brokerage firms.

MarketAxess bolsters derivatives expertise
Kelley Millet has joined electronic credit trading platform MarketAxess as president. The company says that Millet will initially focus on expanding and diversifying its North America business.

Millet comes from Bear Stearns where he was most recently senior md, co-head of global credit trading responsible for origination, syndication, cash, derivatives and flow trading for the investment grade and emerging markets businesses, as well as high-yield derivatives. Millet was integral in merging Bear Stearns cash and credit default swaps businesses on a global basis and was a member of the fixed income management committee.

Prior to joining Bear Stearns in 2001, Millet had a 19-year career with JP Morgan where he held positions of increasing responsibility, culminating in his appointment as global head, capital markets and syndicate.

Gambel to resurface at HBOS?
Richard Gambel, who has left his role as head of the synthetic collateralised debt obligation group at Fitch Ratings in London (see SCI Issue 5), is reportedly on his way to join HBOS. Officials at the UK's fourth largest banking group failed to respond to calls by press time.

Majewski joins Merrill
Merrill Lynch is understood to have taken on Thomas Majewski, formerly md in collateralised debt obligations at Bear Stearns in New York. It is believed that he will join Merrill's global structured credit products group and report to Harin de Silva and Ken Margolis, co-heads of CDOs at Merrill.

Verbeek goes with the flow
Arjan Verbeek has joined BNP Paribas as co-head of flow products in the bank's securitisation group. He is based in London and reports directly to Fabrice Susini, head of European securitisation. Verbeek joins BNP Paribas from Barclays Capital in London, where he was a director within the financial institutions securitisation group since 2003 and was responsible for developing the bank's Master Trust business and structuring covered bond programmes.

Tim Drayson, global head of securitisation at BNP Paribas says: "[Verbeek] will assume responsibility for building up the securitisation group's presence in the UK and Northern European residential mortgage markets, where we feel that traditional RMBS, structured covered bonds and loan portfolio trading will continue to grow over the next few years."

Send all your people moves to John Donnelly

European CRE CDOs close to launch

A round up of this week's structured credit news

European CRE CDOs close to launch
The announcement of the first Commercial Real Estate CDO in Europe is not far away, with the first deal, or deals, expected before year-end. A new report from Barclays Capital suggests that firms that may be working on such a deal include Morgan Stanley, Merrill Lynch, Wachovia and Eurohypo, while other sources add Bear Stearns and even Barclays itself to the list of contenders to issue first.

Barclays report adds that some of these banks might work only as an arranger for specialist CRE collateral managers (such as LNR, Fortress or Cambridge Place). Others might also be the originator of CRE assets in addition to arranging the CRE CDO.

In any event, Barclays says that it expects "to see a small number of 'trial' deals that will test different CRE asset blends and levels of manager involvement to test the rating agency treatment and investor reception. We expect certain arrangers to be more aggressive and launch a CRE CDO deal with a higher percentage of higher risk assets (such as B-notes) and a higher degree of manager flexibility."

After the first phase, Barclays suggests it is likely that there will be a number of precedents with different asset blend, manager flexibility, tranching and pricing combinations. As a consequence, we would expect issuers in the second phase to use these available data points to further optimise their arbitrage."

Meanwhile, Fitch Ratings says that it will be introducing a model that allows commercial real estate CDO managers to monitor and analyse their CREL CDO portfolios on an ongoing basis. The model called CREL Surveyor gives managers the ability to add and delete loans, and update loan performance statistics.

Moody's reports record CDO issuance
The CDO market's total Moody's-rated issuance and number of Moody's-rated deals exceeded records on both counts in the second quarter of 2006, says a new report from the ratings agency. Second quarter CDO rated issuance grew 46% over the first quarter to reach US$68.6bn, and the number of rated deals grew by 49% from the first quarter to reach 146 transactions.

The number of CDOs Moody's rated in the first half of 2006, 244, exceeds the number of deals rated in any full year prior to 2005. Moody's expects total CDO issuance and number of CDOs rated in 2006 to grow 30%-35% relative to 2005, itself a record-making year.

A boom in CLOs and the continuing emergence of high-grade structured finance cash resecuritisations drove much of the issuance, says Moody's. CLOs comprised 28% of the second quarter's rated issuance, jumping 106% from the first quarter. The ratings agency expects hybrid CDOs, CLOs and high-grade structured finance resecuritisations to continue to drive issuance for the rest of the year.

Innovative structured credit fund completed
Prytania Investment Advisors, Dresdner Kleinwort and Deutsche Bank last week completed a new kind of structured finance fund. The Danube Delta Fund is leveraged fund of mezzanine CDO and ABS and is the inaugural deal from London-based Prytania Investment Advisors.

Danube Delta fuses elements of CDOs, Structured Investment Vehicles (SIVs) and Asset Backed Commercial Paper (ABCP) technology to create a highly efficient structured transaction. Charles Pardue, managing partner and founder of the Prytania Group, says: "Our deal has some unique and innovative advantages over traditional CDOs of ABS or CDOs of CDOs. We can buy assets that are optimal for our investors and not directed by currency, supply or rating agencies. We believe the deal produces higher expected equity returns and is less volatile than other CDOs of ABS in a market down-turn, as it is not as leveraged."

The creativeness in the Danube Delta Fund lies in the technology used to leverage the fund, which is determined by a capital model as opposed to being fixed through covenants. The capital model determines whether an asset can be included in the portfolio at the time of purchase as well as the potential leverage possible for each investment. This permits the manager greater flexibility to adapt to market changes.

CDS futures discussions start
German derivatives exchange Eurex began talks with major credit derivatives dealers this week in an effort to enlist their support for the contract Eurex hopes to launch in 2007. The move comes 14 months after Eurex signed an agreement to list futures on iTraxx indices.

Since then, basing a futures contract on CDS appears to have become slightly easier thanks to improved cash settlement and trade confirmation procedures. However, some argue that the appeal of an exchange-traded contract has diminished with the dramatic boom in liquidity and broadening of the user base of OTC contracts.

Moody's highlights new TRUPS CDO risks
In an overview of trust preferred securities backing CDOs (TRUPS CDOs), Moody's Investors Service says that although the asset type's ratings remain exceptionally stable, investors should be aware that the introduction of new collateral classes, such as insurance and real estate investment trust (REIT) obligations, introduces unique risks and analysis requirements.

Both insurance TRUPS and REIT securities offer attractive spreads, Moody's says. However, insurance portfolios are usually less diversified than a portfolio of bank/thrift obligations. REIT obligations are also deeply subordinated and have a high proportion of commercial and residential real-estate exposure. Resecuritised TRUPS CDO tranches of the same vintage generally have a higher amount of issuer overlap, resulting in a higher correlation between tranches.

"While these structures show exceptional ratings stability, with no Moody's downgrades, TRUPS have extended maturities and a longer history needs to be established before final conclusions can be made on this CDO sector," observes Moody's Vice President James Brennan.

T-Zero goes live with prime brokerage service
T-Zero has announced that its first client has gone live using its prime broker platform. Ilex Asset Management has submitted its first trades through T-Zero, using JPMorgan as its derivatives prime broker.

Stephanie Ercegovic, global head of prime brokerage at JPMorgan, says: "The use of T-Zero's Prime Brokerage platform marks a continuation of the move towards hedge funds adopting a standardised approach to trading credit derivatives." T-Zero argues that its service is uniquely placed to facilitate prime brokerage through its agnostic connectivity to other vendors and downstream providers such as the DTCC Deriv/SERV, GlobeOp, Calypso and Thunderhead.

Misys launches new platform
Misys Banking Systems has launched a new platform for its credit derivatives module for Misys Summit FT. The new module extends the firm's original product to address both the current high volumes in the CDS market and also to deliver an adaptive platform to handle more complex instruments.

Dan Cohen, product manager for Misys Summit, explains: "We now see a range of more complex synthetic CDOs, CDS on ABS or any other loan, hybrid structures with credit as an underlying, combined with bonds and other instrument classes. With our new architecture for credit derivatives, we are providing the means to handle all these products within one integrated solution. This gives our customers the means to control their risk exposure fully across asset classes and automatically interact with the likes of DTCC, SwapsWire and Markit within a single STP environment, thereby improving operational efficiency."

MP

Markets for trading credit correlation - part two

The second of two articles by Satyajit Das

Over the last few years, the structured credit market has grown rapidly¹. The emergence of the standard copula model, the availability of implied correlation estimates and the market in standardised credit indices has been crucial to this growth. Market activity has focused on a variety of inter-related approaches:

• CDO investment – this is focused on investing in specific CDO tranches to create (often) highly leveraged credit exposures. These investors frequently take positions on the credit cycle and the level of credit spreads. Credit models and implied correlation are important in understanding valuations at an absolute level as well as benchmarking relative value among different parts of the capital structure.

• Correlation trading/hedging – this is focused on several dimensions:
1. Investment banks managing the risk of residual risk on single tranche CDOs and other structured credit products. The traded correlation market provides a means to value and hedge embedded correlation positions. In practice, the composition of the index and the reference entities underlying the CDO will frequently not coincide. This means that the dealer using the tranched credit index to hedge faces basis risk that must be managed.
2. Investors (particularly hedge funds) and proprietary trading desks at dealers actively trade correlation, usually focusing on the implied versus the historical asset correlation. It also entails the trader trading expectations of actual correlation against implied correlation used to price transactions. In practice, this involves either purchasing or selling specific tranches (primarily CDO equity and mezzanine tranches) or combination trades. Exhibit 2 sets out an example of a typical trade. The transactions entail different positions on net credit delta, spread convexity or default risk. A key motivation is the belief that the CDO tranche market is segmented. The traders are seeking to take advantage of relative values across the capital structure.

In 2005, the problems of trading correlation and modelling inadequacies were exposed³. The catalyst was the downgrade of Ford and General Motors ("GM") to non-investment grade. The downgrade had long been anticipated. However, the significant effect on correlation trading was unexpected.

The downgrades triggered extreme volatility in credit markets. Between late April and early May 2005, the iTraxx credit index spread increased from just around 29bp pa to 53bp pa. In the DJ CDX index, Ford, GM and several other constituents of the index were trading at relatively high spreads (in some cases above 300bp pa). In the period immediately prior to the downgrades, around 50% of the 125 reference entities in the DJ CDX index were trading around 15-30bp pa. In the period immediately after the downgrade, this number dropped to around 25%. Most significantly, average implied correlation changed.

Implied correlation on the equity tranche fell from 24% to around 12% during the same period. In addition, credit spreads of component reference entities within the indices began to move idiosyncratically. The asynchronous movements reflected credit concerns about the automobile sector and the risk of leveraged buyouts by private equity funds of certain firms (specifically within the retail sector).

The most significant effect of the market changes was on investors with long/short positions in the capital structure. Many traders had long equity/short mezzanine positions in credit index standardised tranches or in some cases on customised portfolios. Most banks active in CDOs found themselves with similar positions as a result of normal flow trading. These banks had placed CDO mezzanine tranches with investors and were effectively long the equity and senior tranches. This reflected the normal flow of business from credit investors.

The positions had provided strong carry. In some cases, the carry was up to 15% ($1.5 million on a $10 million) of a position. The market changes caused a sharp increase in spreads on the equity tranche. In early March 2005, the equity tranche traded at 27% upfront. By mid May 2005, the equity spread traded at over 60%. This triggered large mark-to-market losses on investors in the equity tranche.

Theoretically, the loss on the equity tranche should have been offset by gains on the short mezzanine tranche position. In fact, the spread on mezzanine tranches fell generally by around 20bp. The behaviour of the mezzanine tranche reflected the combined effect of the market changes in credit spreads and, particularly, correlation. It was also exacerbated by changes in the hedging models and re-hedging activity. Most significantly, the presence of large similar positions that were now being simultaneously unwound further exacerbated the problems.

It is believed that dealers and investors in structured credit products suffered large mark-to-market losses during this period. The results of this experience were as follows:

• A number of investors and dealers have discontinued or scaled down their activity in structured credit and correlation trading.

• Dealers have changed their trading emphasis. Increasingly, traders have sought to sell off the equity and senior tranche risk. The aim is to reduce the correlation exposure. This has led to some product innovation including the creation of capital guaranteed equity tranches and leverage super senior structured notes. It is not clear that whether these developments presage a shift away from single tranche structures to a more traditional model where a large part of the entire capital structure is placed with investors.

Developments in modelling of structured credit products and particularly implied correlation are interesting. The concept of implied correlation appears to have been driven substantially by the need to benchmark and explain the valuation of CDOs and other structured products. The primary aim appears to have been the desire to increase apparent transparency. This seems to have been at the expense of a rigorous and defensible model. The recent experience is evidence of these tensions in the market.

Notes
1. See Boughey, Simon "The Correlation Conundrum" (April 2004) Risk Credit Risk Supplement S11-S12; Patel, Navroz "Cracking The Correlation Conundrum" (August 2004) Risk 40-42.

2. See Tavakoli, Janet M. (2003) Collateralized Debt Obligations And Structured Finance; John Wiley & Sons, Inc., New Jersey at 261-265.

3. See Patel, Navroz "Crisis of Correlation" (June 2005) Risk 46-48; Jeffrey. Christopher "Credit Model Rethink" (August 2005) Risk 36-38; Ho, Hann "Balancing The Capital Structure" (September 2005) Risk 20-22.

© 2006 Satyajit Das All rights reserved.
An earlier version of this paper appeared as "Trading Implied Default Correlation" (July 2006) FOW 47-52. This paper is based on Das, Satyajit (2005) Credit Derivatives, CDOs and Structured Credit Products – 3rd Edition; John Wiley, Singapore at Chapter 4. See the original text for detailed sources and references.

About Satyajit Das
Satyajit Das works in the area of financial derivatives and risk management. He is the author of a number of key reference works on derivatives and risk management. His works include Swaps/ Financial Derivatives Library – Third Edition (2005, John Wiley & Sons) (a 4 volume 4,200 page reference work for practitioners on derivatives) and Credit Derivatives, CDOs and Structured Credit Products –Third Edition (2005, John Wiley & Sons). He is the author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall), an insider's account of derivatives trading and the financial products business filled with black humour and satire. The book has been described by the Financial Times, London as " fascinating reading ... explaining not only the high-minded theory behind the business and its various products but the sometimes sordid reality of the industry". He is also the author (with Jade Novakovic) of In Search of the Pangolin: The Accidental Eco-Tourist (2006, New Holland), an unique travel narrative offering passionate and often poignant insights into the natural world and the culture of eco-travel.