Timeline for How does tranching cause leverage?
Current License: CC BY-SA 3.0
8 events
| when toggle format | what | by | license | comment | |
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| Sep 23, 2015 at 20:13 | vote | accept | AfterWorkGuinness | ||
| Sep 23, 2015 at 19:30 | comment | added | realizedvariance | Yup that's correct. There is some basis risk in that position relative to the index because the tranche is also affected by other things (base correlation, etc.), but you're right on where the concept of leverage comes in with tranches. | |
| Sep 23, 2015 at 18:39 | comment | added | AfterWorkGuinness | Thanks for the detailed response. I think I get it now. Leverage exists because by investing \$x in the tranche, I have a position that is equivalent to $\Delta_{tranche}$ * a position in the underlying index. Right? | |
| Sep 23, 2015 at 18:21 | comment | added | realizedvariance | Ok, I'll elaborate. When people trade these indices to hedge, they are often looking for mark-to-market gains, not necessarily hold to maturity default payouts. As default probabilities and spreads widen, equity tranches become more expensive because the probability of that 26.6% payout increases vs. only an increased prob. of 0.8% payout on the index. The difference in PnL from those sensitivities to spread is called tranche delta and is the leverage factor. Just like a call option on a stock might move 0.5x of the stock, the mark-to-market of an equity tranche might move ~5x of the index. | |
| Sep 23, 2015 at 16:11 | comment | added | AfterWorkGuinness | I'm a bit lost. I followed your example that 1 default is only 0.8% loss to the total index but a 26.6% loss to the equity tranche, but I lose you after that. | |
| Sep 23, 2015 at 5:55 | history | edited | realizedvariance | CC BY-SA 3.0 |
deleted 1 character in body; edited body; deleted 1 character in body
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| Sep 23, 2015 at 5:16 | review | First posts | |||
| Sep 23, 2015 at 7:49 | |||||
| Sep 23, 2015 at 5:15 | history | answered | realizedvariance | CC BY-SA 3.0 |