US Treasuries 40x riskier than last year?

[Aeson]

Does the CDS on sovereign debt pose the same type of systemic risk that it did on the MBS market?

[KrazyHorse]

Originally posted by Aeson
Ok, that answers my question as to why they still buy them for US treasuries. (If it only payed out in default)

It does only pay out in default.

My point in saying that it is an (imperfect) hedge against bond price movements is the CDS as a contract has value associated with it (assuming that you think there is at least SOME chance it will pay out in case of default!). Insofar as the price of a bond drops due to a perceived increase in the risk of its default the CDS will hedge against price movements (since the value of a CDS goes up as the chance of default increases).

[KrazyHorse]

If you think that there's no chance of any CDS on US Treas. paying out in any instance of default then all CDS on US Treas. are worthless (and should also be worthless as hedges; the change in price of an asset which is always worthless is always 0).

[Kidlicious]

This looks like another case of the more people buy of these the higher the price goes and the more worthless they become.

[Kuciwalker]

"more worthless" is an interesting concept

[Aeson]

Ah, ok.

So in this case, the risk of a default on the CDS in the event of a US default is mitigating the price increase of the CDS due to the risk that the US could default?

Essentially the risk of the US defaulting is both increasing (directly) and decreasing (indirectly, but < 100% effect) the value of the CDS?

:boggle:

[KrazyHorse]

Originally posted by Aeson
Ah, ok.

So in this case, the risk of a default on the CDS in the event of a US default is mitigating the price increase of the CDS due to the risk that the US could default?

Of course.

Essentially the risk of the US defaulting is both increasing (directly) and decreasing (indirectly) the value of the CDS?

:boggle:

No. express things as:

1) The probability that the US Gov't will default (call event of default D)
2) The probability that your counterpary will default GIVEN a US default (call event of counterparty default C)

Let the notional amount be N and assume that Treasuries will be worthless in the event of a default. The risk neutral price S of a CDS is:

S = N * P{D} * (1 - P{C|D})

P{D} increasing does not necessarily change P{C|D}, though it might (if, for instance, demand for Treas CDS increases to the point where companies who write Treas CDS are at increased default risk if Treas defaults).

[Aeson]

Originally posted by KrazyHorse
P{D} increasing does not necessarily change P{C|D}, though it might (if, for instance, demand for Treas CDS increases to the point where companies who write Treas CDS are at increased default risk if Treas defaults).

In my "essentially" I was referring to this "might", or at least in part. This "might" is risk to whatever extent, and would have a downward influence on price to the extent of the risk.

Though there's more to it, just not sure how to describe what I'm thinking. If you look at the "given" of US default, it's a factor (yes, a given... but still a factor) in C. C being a negative influence on price. If that explanation doesn't make sense, I understand... it doesn't make much sense to me either.

Neither does the whole deal... I personally would be writing as much CDS on US Treasuries as I possibly could if only I could fool people into thinking I could possible back it... at least that is if I didn't have a soul or conscience or whatever you want to call it. My thesis would be that if the US Gov can default, so can I. But until then... let the good times roll!

[KrazyHorse]

Originally posted by Aeson
Neither does the whole deal... I personally would be writing as much CDS on US Treasuries as I possibly could if only I could fool people into thinking I could possible back it.

LOL welcome to the CDS market.

[chequita guevara]

Originally posted by Kuciwalker
"more worthless" is an interesting concept

English is not a logically constructed language. "More worthless" is a common enough phrase.

[chequita guevara]

I suppose if the CDSs are held in non-U.S. firms, the chance of them being able to pay out in the event of a U.S. default increases. Unless it's backed up with foreign currency, I can't see the point of getting insurance in dollars against the value of the dollar.

[Kidlicious]

From the Bloomberg article:

Banks are now driving the cost of debt protection to records as they seek to guard against losses on contracts bought from money-losing hedge funds.

Is that where the bailout money is going?

[KrazyHorse]

You generally take CDS in the denomination of the bond (e.g. Pakistani bond CDS pay out in pakistani rupees).

If you want, you can simply add in a call option on the currency of your choice to lock in a minimum value for the dollars you get from the CDS.

[Aeson]

Originally posted by Kidicious
Is that where the bailout money is going?

It's probably going to bonus pools (not directly of course, but instead of having to raid their bonus pools to stay solvent, they don't) and buying out smaller banks.

Gotta stay ahead of the "too big to fail" cutoff. (Poor Lehman )

[Kidlicious]

Also, the article says the price is driven by speculation that the credit rating of the US Treasuries will deteriorate, not because investors actually believe the US will default.