The risk management implications of using end of day consensus pricing for single name CDS
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The risk management implications of using end of day consensus pricing for single name CDS Tavy Ronen1 · Oleg Sokolinskiy1 · Ben Sopranzetti1
© Springer Science+Business Media, LLC, part of Springer Nature 2019
Abstract When markets are opaque, market participants rely to a large extent on end-of-day consensus prices published by service providers; such as in the case of the single name credit default swaps (CDS) market. End-of-day consensus CDS prices are critical for valuation and risk management purposes, since profits and losses of inventory positions can be determined by marking to market using end-of-day consensus prices. Deviations between endof-day prices and intraday quotes can occur due to many factors, including market illiquidity. This paper identifies determinants of such deviations, lays out the times when they can occur, and examines the impact of these deviations for risk management purposes. End-ofday consensus prices are representative of average and median intraday quotes; however, in periods of high volatility and market distress, end-of-day prices can notably differ from actual intraday quotes. Such analysis can allow market participants to better rely on end-ofday consensus prices during normal market conditions. Keywords Credit default swaps · Consensus pricing · Risk management · Default risk JEL Classification G1 · G11 · G12 · G13 · G17
1 Introduction Risk managers and other market participants rely on timely and accurate prices in order to determine the gains and losses associated with their transactions. When intraday prices are reliable and available, the decision to buy or sell an asset and the settlement of any corresponding profits or losses are determined by actual intraday quotes. In this case, a risk manager knows at the time of their decision the accounting profit and losses that will be * Ben Sopranzetti [email protected] Tavy Ronen [email protected] Oleg Sokolinskiy [email protected] 1
Department of Finance and Economics, Rutgers Business School: Newark and New Brunswick, Piscataway, USA
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associated with a trader’s action. However, when markets are opaque, and reliable intraday prices are not available, participants must rely on end-of-day consensus prices. These consensus prices are determined and published by reputable service providers, and their calculation algorithms constitute closely guarded intellectual property. Market participants may elect to mark their existing positions to market using consensus prices, even though the decision to buy or sell is still determined by actual quotes. Thus, there can be a disconnect between the quoted prices that drive trading decisions and the end-of-day consensus prices used to determine any associated mark-to-market profits and losses. While this disconnect may not be a major concern when intraday volatility is low and actual intraday quotes are close to end-of-day consensus prices, it can have grave consequences for firms in financial distress when qu
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