âCDO analysts have been forced to make simple assumptions about default correlations and credit spreads because of a lack of data. Research by Kamakura and many others shows that credit spreads are not determined by default probabilities and recovery rates alone,â commented Warren Sherman, Kamakura President and Chief Operating Officer. âThe premium in credit spreads above and beyond the loss component is a function of market conditions, macro-economic factors and other company-specific information. Kamakuraâs implied credit default swap quotations reflect this reality as observed in a data base of more than 500,000 credit default swap bids, offereds and traded prices. This credit spread information, combined with our dramatically expanded default correlation capability, gives KRIS users and users of the Kamakura Risk Manager enterprise wide software package unparalleled accuracy in modeling total risk and correlated default in the manner recommended recently by Dr. John Frye of the Federal Reserve Bank of Chicago. The simple copula approach and the related assumption that all pairs of companies have the same default correlation lead to the kind of losses outlined in the Wall Street Journal on August 12, 2005. KRIS offers clients a much more accurate spread and correlation technology.â
The implied credit default swap quotes are an add-on to the basic KRIS default probability and correlation service. Bid, offered and traded CDS prices are calculated using a hybrid model developed by Kamakura. This hybrid model incorporates the KRIS reduced form default term structure and its inputs, a Merton structural model default probability, ratings, and macro-economic factors. CDS quotations are available for 1, 2, 3, 4, 5, 7 and 10 year maturities.