Morgan Stanley estimates LCDS cancelation risk

In a new research piece entitled 'LCS, after the trade' Morgan Stanley researchers look at the problem of pricing the cancellation risk in "non-cancellable" loan credit default swaps, as used in the North American market including the new LCDX index. At present there is no market standard for unwinding LCDS trades because this requires an assumption about the final maturity of the contract.

The analysts say that the probability of a "no deliverables" situation leading to a LCDS contract being cancelled is not low, but it is probably lower than implied by historical ratings transitions from high yield to investment grade - which is the event likely to trigger loan repayments.

Source: Morgan Stanley