CDR recommends tranche play as correlation falls

Following the recent drop in CDX IG correlation, Credit Derivatives Research has recommended taking selective bets hedged with index as the best way to play the tranche market currently. CDR favours going long the CDX seven-year 7-10% tranche and short 10-year 10-15%, with both hedged individually against the index.

CDR says that positive actions by monolines have decreased tail risk for the IG indices, leading to a subsequent drop in systemic risk last week. Though index spreads did not move much and were largely range bound, tranche risk re-allocation was evident with the senior and super senior tranches outperforming relative to equity and junior mezzanine tranches.