First to Default CDS/Basket CDS

[ChadWOB]

The material states the value of the basket CDS decreases as the correlation of the underlying references increases. This seems counterintuitive to me. If the probability of default increases as a result of increased correlation among references, wouldn't the basket CDS be MORE valuable? The protection against a more probable default event seems to be more valuable here.

What am I missing? Are we talking about 'value' relative to the buyer or seller?

Thanks,
Chad

 

[David Harper CFA FRM]

Hi Chad,

Can you see this: http://forum.bionicturtle.com/threads/basket-cds-value-correlation.4491/#post-11605

I'm not sure to what you refer, but it varies depending on junior (1st to default) versus senior (nth to default), from the T6 Notes:

So both can be true if your statement refers to the senior tranches and the other refers to the junior (e.g., 1st to default, 2nd to default) ... but aside from that, by viewing as a PRICE we don't need to worry about buyer/seller: as default correlations INCREASE, price (premiums) on 1st-to-default go down and prices on senior nth-to-default go up, where price/value is spread premium. So i think your statement ( If the probability of default increases as a result of increased correlation among references, wouldn't the basket CDS be MORE valuable?) is true of the senior tranches. Thanks,

 

[ChadWOB]

David,

Thanks for this answer. I understand.

Thanks,
Chad