TABX and mezz SF CDO spreads should converge, says JP Morgan research

In a report entitled ‘The TABX/mezz SF basis’ JP Morgan researchers measure how much of the difference between tranched ABX spreads and those on CDOs of mezzanine ABS can be explained by differences in the credit quality of the underlying portfolios.

They find that much of the difference can be explained by the significantly worse collateral quality of the ABX index, but that the gap is too wide, and they expect spreads to converge.

To put on a convergence trade, the researchers suggest buying protection on double A to triple B CDO securities and going long the 10-40% tranche of ABX.

Source: JP Morgan