Member-only story

Subprime Crisis: Pricing, Hedging, CVA, MBS Ratings, and Liquidity

Graham Blair

·11.5k Followers· Follow

Published in Credit Risk Frontiers: Subprime Crisis Pricing And Hedging CVA MBS Ratings And Liquidity (Bloomberg Financial 137)

5 min read · 2 weeks before

660 View Claps

39 Respond

Save

Listen

The subprime mortgage crisis of 2007-2008 had a profound impact on the global financial system. It exposed a number of fundamental weaknesses in the financial industry, including a lack of transparency, a lack of regulation, and a reliance on complex and risky financial instruments.

One of the most important lessons learned from the crisis was the importance of proper pricing and hedging of subprime mortgages. This was a failure that allowed the crisis to escalate and caused significant losses for investors.

In recent years, there have been a number of reforms implemented to address the weaknesses in the financial industry. These reforms have made the financial system more resilient to shocks, but they have also increased the cost of ng business.

Credit Risk Frontiers: Subprime Crisis Pricing and Hedging CVA MBS Ratings and Liquidity (Bloomberg Financial 137)

Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity (Bloomberg Financial Book 137)

by Damiano Brigo

5 out of 5

Language	:	English
File size	:	21107 KB
Text-to-Speech	:	Enabled
Screen Reader	:	Supported
Enhanced typesetting	:	Enabled
Print length	:	1178 pages
Lending	:	Enabled

Pricing Subprime Mortgages

Subprime mortgages are loans made to borrowers with poor credit histories. These borrowers are considered high-risk, and as such, they are charged higher interest rates. The pricing of subprime mortgages is a complex and risky process.

The main factor that determines the price of a subprime mortgage is the borrower's credit score. Borrowers with higher credit scores are considered less risky and are charged lower interest rates. Borrowers with lower credit scores are considered higher risk and are charged higher interest rates.

In addition to the borrower's credit score, there are a number of other factors that can affect the price of a subprime mortgage. These factors include the loan amount, the loan term, and the type of property being financed.

Hedging Subprime Mortgages

Hedging is a risk management technique that is used to reduce the risk of a financial loss. Hedging a subprime mortgage can involve the use of a variety of financial instruments, such as credit default swaps (CDSs) and mortgage-backed securities (MBSs).

CDSs are contracts that provide protection against the default of a loan. If a subprime mortgage goes into default, the holder of the CDS can make a claim on the contract and receive a payment. MBSs are pools of subprime mortgages that are sold to investors. MBSs are often hedged with CDSs to reduce the risk of a default.

CVA

Credit value adjustment (CVA) is a charge that is assessed to a financial institution to reflect the risk of a counterparty defaulting on a contract. CVA is calculated based on the counterparty's credit rating, the amount of the contract, and the maturity of the contract.

The CVA charge can have a significant impact on the profitability of a subprime mortgage. A counterparty with a low credit rating will result in a higher CVA charge, which will reduce the profit margin on the loan.

MBS Ratings

MBSs are rated by credit rating agencies to assess the risk of default. The ratings range from AAA (highest risk) to D (lowest risk).

The ratings of MBSs are based on a number of factors, including the credit quality of the underlying mortgages, the structure of the MBS, and the level of subordination. Subordination refers to the order in which investors are paid in the event of a default.

The ratings of MBSs can have a significant impact on their price. A MBS with a higher rating will be more attractive to investors and will sell for a higher price.

Liquidity

Liquidity is the ability to convert an asset into cash quickly and easily. Subprime MBSs are not very liquid. This is because there is a limited number of investors who are willing to buy them.

The lack of liquidity can make it difficult to sell subprime MBSs in times of stress. This can lead to a decline in their price and an increase in the cost of borrowing for subprime mortgage borrowers.

The subprime mortgage crisis was a major financial crisis that had a profound impact on the global financial system. It exposed a number of fundamental weaknesses in the financial industry, including a lack of transparency, a lack of regulation, and a reliance on complex and risky financial instruments.

The pricing and hedging of subprime mortgages is a complex and risky process. It is important to understand the risks involved before investing in subprime mortgages.

Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity (Bloomberg Financial Book 137)

by Damiano Brigo

5 out of 5