Kamakura Corporation today announced a dramatic expansion of its Kamakura Risk Information Service default probability and correlation service.
The KRIS service now includes implied credit default swap quotations for 16,000 corporations in 25 countries covered by the KRIS service. At the same time, Kamakura announced that it has more than doubled the number of company-by-company default correlations to more than 2.8 billion pairs of companies. This allows users to avoid the common but dramatically incorrect assumption that all pairs of companies in a portfolio or collateralized debt obligation tranche have the same default correlation.
CDO 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," commented Warren Sherman, Kamakura President and Chief Operating Officer. "The premium in credit spreads above and beyond the loss component is a function of market conditions, macro-economic factors and other company-specific information. Kamakura's 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."
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.
The default correlations are consistent with a recent paper by Kamakura's Professor Robert Jarrow and Dr. Donald R. van Deventer (RISK Magazine, January 2005) and a subsequent article by Dr. John Frye in the July issue of RISK.