China Credit Risk Mitigation.docx

China Credit Risk Mitigation.docx

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ChinaCreditRiskMitigation

China’sCreditRiskMitigationToolsPricingBasedonJarrow-TurnbullModel

WuMin,ZhangQiang*

（CollegeofFinanceandStatisticsofHunanUniversity,HunanChangsha,410079）

Abstract:

Creditriskmitigationtool（CRM）isaninnovativecreditriskmanagementtoolthatpilotlaunchedbytheinter-bankmarketin2010,itstrippingandpricingthecreditriskofcommercialpaper,medium-termnotes,bankloansandotherassets,andtransferredtherisktootherinvestment,theirintroductionradicallychangedthetraditionalfeaturesofcreditriskmanagement.First,thepricingofthepilotstatusofCRManalysis,theimpactoffactorsincludingCRMpricingrisk-freeinterestrate,theunderlyingbond'sriskexposure,defaultprobability,lossgivendefaultrateandduration,CRMdeadlines.Secondly,theintroductionofJarrow-Turnbullmodel,thepricingofcreditriskmitigationtoolstomeasureandfoundthatinterestratesorcentralbankbills,treasurybondsoverthesameperiodastheCRMbenchmarkinterestrateismoreappropriate,andtheJarrow-Turnbullmodelfordifferenttime,differentlevelsofCRMpricingofcreditdiscrimination.MorereasonabledealwiththeissueofpricingisclosertoCRM,CRMproductsforourcurrentpricing.Finally,proposeCRMpricingoptimizationstrategies,includingcompletingtheunderlyingdatabase,exploringRisk-freeinterestrate,innovativeunderlyingbondratingsystem,guidingCRMmarketdiversificationandoptimizationofmakertradingsystem.

Keywords:

Creditrisk;Riskmitigation;Riskpricing;Jarrow-TurnbullModel

Introduction

Bytheendof2010,thebalanceofChina’screditbondsreached4trillionRMB.Balanceofcommercialbankloansreached31.09trillion,10trillionofwhichgotocreditloans.Meanwhile,risksoffinancialproductslikebondsandloansarechangingfromsingleinterestrisktotwo-tierriskstructurecontainingbothinterestriskandcreditrisk.Becauseofthescarcityofcreditriskmanagementtools,itisdifficultforcommercialbanksandotherinstitutionalinvestorstoeffectivelyavoid,transfer,hedgerisksandoptimizeresourceallocationsandthereforereducesystemicrisks.Inthisoccasion,NationalAssociationofFinancialMarketInstitutionalInvestors（NAFMII）establishedtheChinaBondInsuranceCo.Ltd（CBIC）,in2009,withthepurposeofdiversifyingcreditriskmanagementtoolsfortheinvestors,amelioratingcreditrisksharingmechanismandavoidingsystemicrisks.Between2010and2011,CBICcreatedproductslike“ChinaBondAgreementI”,“ChinaBondAgreementII”,“ChinaBondAgreementIII”and“ChinaBondAgreementIV”.CBICthusbecameoneoftheforerunnersinCRMcreationinChina’sfinancialmarketandthebiggestmarketmaker.InOct2010,NAFMIIofficiallyissuedthe“GuidelineforthepilotbusinessofCreditRiskMitigationinInter-bankMarket”,makingtheofficiallaunchoftheCRMpilotbusiness.

ThedevelopmentofCRMpilotbusinessisnotsmooth,though.FromNov2010whenCRMwasofficiallytradedtoMay2011,only9CreditRiskMitigationWarrants（CRMW）wereissuedbytheinter-bankmarket.InApril2011,completecancellationoftheCRMWissuedin2010（HSBCChinaCRMW001）byHSBCbeforehand,furtherworriedthebusinessandacademicsregardingthepilotbusinessofthisinnovativefinancialproduct.

1SurveyofResearchAtHomeandAbroad

1.1SurveyofResearchAbroad

Jarrow-TurnbullCreditRiskPricingModelinitiallyappearedinRobertJarrow&StuartTurnbull（1995）[1].LaterthatmodelwasappliedtothecalculationofBondDefaultRateandpricingofcreditproductslikeCreditDefaultSwaps（CDS）.TheBaselCommittee（1999,2004）[2]firstintroducedtheconceptofCreditRiskMitigationatthebeginningofthe20thcentury,andgavethoroughintroductiontothetechnicalframework,coverage,mechanism,capitalchargeandinformationexposureofCRMindocumentsincluding“BaselNewCapitalAccord”and“InternationalConvergenceonCapitalMeasurementandCapitalStandard:

RevisedFramework”.Later,bystudyingtherelationshipbetweenCDSpricingandobjectbondyield,JohnHull,MirelaPredescu,andAlanWhite（2004）[3]etall,foundthattheCDSpricingriskfreebenchmarkinterestrateofCanadianCDSfallswithinthefive-yearaverageswapinterestrateandtheinterestrateofthetreasury.Bringingdowntheratingofobjectbondhassignificantinfluenceondefaultrateandpricechange,yetdowngradingandnegativelyprospectingitsdefaultrateandpricechangedoesn’thaveagreatinfluence.ChristianWeistroffer（2009）[4]，Duquerroy&Gex（2009）[5]，Ramacont（2010）[6]tooktheviewthatCRMprovidesmoreeffectivemeansofcreditmanagementforcostcontainmentofcommercialbanksandliquidityenhancement.Italsoprovidesnewinvestmentchannelsforinstitutionalinvestmentsandhelpsimprovetheefficiencyandstabilityoffinancialsystems.Garrett（2009）[7]pointedoutthattheadvantagesofCRMliesinfacilitatingcreditrisktransferandadjustmentofbalancesheets,whileitsdisadvantagesliesinthefactthat,CRMisbasicallyazero-sumgame,andcanonlytransfercreditrisks.InappropriateuseofCRMislikelytorepeatthetragediesofAIGandLehmanBrothers.Stulz（2010）[8]studiedtheinfluenceofCRMoncompanyandsubprimemortgage,andarguedthatthefundamentalcauseofthecurrentfinancialcrisisliesinthelackofexpectationofinvestorsandfinancialinstitutionsonassetpricefall,aswellastheexcessleverageoffinancialinstitutions.CDS,tothecontrary,issymptomratherthancauseofthecrisis.

1.2SurveyofResearchAbroad

AccordingtotheGuidelinepublishedbyNAFMII（2010）,China’sCRMincludesCreditRiskMitigationAgreements（CRMA）,CreditRiskMitigationWarrants（CRMW）andothersimple,basiccreditderivativeproductsusedtomanagecreditrisks.TheyareanaloguestoCreditDefaultSwap（CDS）:

（1）CRMAisakindoffinancialcontractacceptedbybothbuyersandsellers.Withinacertainperiodinthefuture,buyersofcreditprotectionaresupposedtopaythecreditprotectionfeetocreditprotectionsellersaccordingtoagreedonstandardandprocedures,whilesellersoughttoprovidecreditriskprotectionserviceforbuyerswithregardtoagreedonobjectdebt.

（2）CRMWiscreatedbyinstitutionsoutsideofobjectentities,providescreditprotectionservicestoholdersregardingbondsorsimilarobjectdebt,andcancirculateonthemarket.Uptonow,researchonCRMinChinafocusesonpolicyresearch.ZhaiChenxi（2008）[9]hasdonetheoreticalcalculationofpricingofCDSproductsdenominatedinRMB,basedonapplicationofJarrow-TurnbullmodelinpricingofCDSproducts.ShiWenchao（2011）[10]byanalyzingthebackground,implicationandinstitutionalarrangementsofCRM,exploredtheconstructionoftheCRMmarketfromtheperspectivesofinstitutionalframeworkdesign,investorbuildup,marketmechanismandexternalenvironmentconstruction,creditriskpricing,aswellasinternationalcomparisonofCRMmarket,etc.

1.3Summary

Accordingtothesurveyabove,researchintheareaofcreditriskmitigationproductssuchasCDSandCRMathomeandabroadismostlyfocusedonproductdesign,mitigationeffects,capitalsupervisionandriskmanagement,etc,andrelativelyweakonproductpricingresearch..AndtheshorttimesincelaunchofCRM,CRMpricingbenchmarkinterestratesarestillnotperfect,thelackofbasicdatabasepricing,pricingmodelsandmethodsofresearchisstillinitsinfancy,themarketplayersandregulators,manyoftheirproblemsisnothigherrecognition.Therefore,thisarticletriestocombinethereleasestatusoftransactionpricingofCRMsinceCRMlaunchednearly6months,analysespricingfactorsofCRMcomprehensivelyandsystematically,andexploretheeffectivenessofJarrow-TurnbullmodelonCRMpricing,thenputforwardoptimizationmeasuresofCRMpricing.

2AnalysesonFactorsInfluencingCRMPricing

AsFigure1shows,CRMAiskindofafinancialcontractwithunderlyingmechanismlikethis:

buyersofcreditriskprotection,intheattempttopreventcrediteventsfromhappeningonthereferenceentity（objectbondscarryingcreditrisks）,payafixedamountoffeesregularlytosellersofcreditriskprotection.Sellers,inreturn,providecreditriskprotectiontothebuyerswithregardtothereferenceentityinpredeterminedperiodoftime.BymeansofCRMtransaction,bothpartiescansuccessfullytransferandtransformcreditrisks.CRMWisdifferentfromCRMAinthatitisestablishedbyanindependentthirdparty,soneitherbuyersnorsellersneedtoholdanyreferenceentitybonds.

Fig.1.ThebasicprinciplesofCRMAdesign

TheunderlyingmechanismofCRMshowsthatthetheoreticalbaseforCRMpricingisthetheoryofdefaultprobabilityanddefaultlossrate,andisrelatedtoindexeslikeriskexposureofobjectbonds,defaultprobability,defaultlossrateandterms,etc.Fromtheprospectiveofmarketpricingmechanism,themajorityofmarketentitiesrelyonexistingobjectbondyieldcurves,andpriceusingsimplifiedcreditinterestratedifferencemethodsandbinarytreemethods.Orpricebyrisk-freeinterestratediscountafteradjustingliquiditypremium,onthebasisoftheinterestratedifferencebetweentheyieldcurveofbondswithsamecreditratingasCRMobjectbondsandtheyieldcurveoffinancialbondsornationaldebt（Shi,Wenchao,2011）[10].Meanwhile,accordingtotheinterestratetermstructuretheory（Hicks,1939）[11],thepriceoflong-termCRMishigherthanthatofshort-termCRMduetotheliquidityriskpremiumofCRM.Allinall,majorfactorsinfluencingCRMpricingincluderisk-freebenchmarkinterestrate,riskexposureofobjectbond,defaultprobability,de