Morgan Stanley publishes research on TABX valuations

In a new research report entitled ‘Correlation courts sub-prime stress’ Morgan Stanley researchers point out that derivatives tend to develop and mature more rapidly in times of volatility, and they expect the current volatility in sub-prime mortgages to have a similar effect.

The report estimates that daily ABX volumes are less than 1% of CDX volumes of $40 billion to $50 billion, and that tranched ABX volumes are an even smaller proportion of their corporate equivalents. However, the researchers say that a more transparent price discovery process could be unleashed by the trading of standardised index tranches.

Morgan Stanley points out that ABX tranches are less representative of the home equity ABS market than are corporate tranches. The research also points out that unlike corporate structured credit, there is significant potential that the constituent bonds in the TABX portfolios can be fully written down. Therefore tranched ABX and ABS CDOs should be thought of as akin to CDO-squared structures.

The researchers conclude that according to their models, the 0-5%, 5-10% and 15-25% tranches of ABX BBB- are deeply ‘in-the-money’ from the point of view of protection buyers. The 25-40% tranche is close to ‘at-the-money’ and the 40-100% tranche is ‘out-of-the-money’ for protection buyers.

Source: Morgan Stanley