The Basel Committee has released its Revisions to the Basel II market risk framework – updated as of 31 December 2010, complete with a PDF that has now crashed my Internet Explorer twice. The press release states:
Since the financial crisis began in mid-2007, an important source of losses and of the build up of leverage occurred in the trading book. A main contributing factor was that the current capital framework for market risk, based on the 1996 Amendment to the Capital Accord to incorporate market risks, does not capture some key risks. In response, the Basel Committee on Banking Supervision (the Committee) supplements the current value-at-risk based trading book framework with an incremental risk capital charge, which includes default risk as well as migration risk, for unsecuritised credit products. For securitised products, the capital charges of the banking book will apply with a limited exception for certain so-called correlation trading activities, where banks may be allowed by their supervisor to calculate a comprehensive risk capital charge subject to strict qualitative minimum requirements as well as stress testing requirements. These measures will reduce the incentive for regulatory arbitrage between the banking and trading books.
An additional response to the crisis is the introduction of a stressed value-at-risk requirement. Losses in most banks’ trading books during the financial crisis have been significantly higher than the minimum capital requirements under the former Pillar 1 market risk rules. The Committee therefore requires banks to calculate a stressed value-at-risk taking into account a one-year observation period relating to significant losses, which must be calculated in addition to the value-at-risk based on the most recent one-year observation period. The additional stressed value-at-risk requirement will also help reduce the procyclicality of the minimum capital requirements for market risk.
As I have often stated here, I’m not completely certain that this is a step forward. Trading is functionally different from holding, and a trader may well wish to hold a position in El Crapola Corporation paper for a while because he knows he’s got a buyer. Problems can arise – and did arise during the crisis – when the paper that couldn’t be sold was kept on the trading book, instead of migrating to the banking book as it aged.
I haven’t seen any discussion of this point anywhere, so this is either a very profound point, or a very naive one. Take your pick.
Sell Side analysts are a hoot:
So, when analysts are raising their recommendations on a stock, that should be telling people to buy more of it (or, sell less of it); when they are cutting their recommendations, that’s telling people to sell more (or, buy less). In both cases, especially when you’re talking about well-known analysts at major firms, we would expect this to filter down to the stocks themselves – downgrades serve to drive stock prices lower, upgrades to push them higher. Right?
As it turns out, not so much. In fact, it would appear that as long as they spell your company’s name right,upgrades and downgrades are both good news for your stock.
Laszlo Birinyi and Amanda Crumb, of independent stock-market research firm Birinyi Associates Inc., recently analyzed more than 2,700 upgrades and downgrades issued by 19 Wall Street firms since the market bottomed in March, 2009. They found that – as expected – upgraded stocks rose an average of 2.03 per cent on the day of their upgrade, while downgraded stocks averaged a 2.02-per-cent drop on the day of the news.
But once they looked even a mere week further out, this expected trend no longer held. Yes, the upgraded stocks continued to move higher, both on an absolute basis and relative to the S&P 500 benchmark, and these gains got stronger as time passed. What wasn’t expected, though, was that the same was also true for the downgrades.
Downgraded stocks not only typically rose in the weeks to months following the downgrades, but after an initial underperformance relative to the S&P 500 in the first week, they significantly outperformed the benchmark at one month and three months out. What’s more, this surprising upward trend among downgrades didn’t appear to have been skewed by some large incorrect calls at a couple of firms; the gains were seen across virtually all 19 investing firms.
Remember 2005? Remember how it was so friggin’ obvious that subprime was a nascent disaster? Remember giving learned lectures about how big the real estate bubble was? Remember how it was all the fault of evil bonus-loving Wall Street vampires? I don’t. The Boston Fed has a similarly faulty memory. And, it would seem, John Paulso, most famous for making a fortune betting against it, and second-most famous for being disrespected in the Boston Fed paper, can’t remember that either:
As one of the few winners from the financial crisis, John A. Paulson looks pretty smart. His hedge fund firm, Paulson and Company, netted $15 billion betting against the subprime mortgage market — and he continues to profit from his wager on gold.
But in audio recordings recently released by Financial Crisis Inquiry Commission, Mr. Paulson reveals just how much flack he got from professionals and peers, who in the early days of the turmoil derided his big bet as the misguided move of a “novice.”
“Most of them, when we did express our viewpoints, thought we were inexperienced novices in the mortgage market,” Mr. Paulson said in an interview with the commission in 2010. “We were very, very much in the minority. If I said a thousand-to-one, we were the one. Even friends of ours thought we were so wrong, they felt sorry for us.”
The Evil, bonus-seeking Fabulous Fab, as one may recall, was the one who (as discussed on April 21, 2010) conspired with the smart cookies at ACA and IKB to fleece the poor neophyte. Oh, no, wait, sorry, it was the other way ’round.
It was another relatively quiet, slowly rising day on the Canadian preferred share market, with PerpetualDiscounts up 5bp, FixedResets gaining 1bp and DeemedRetractibles winning 9bp, all on quiet, “normal” volume with very little price volatility.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1549 % | 2,397.6 |
| FixedFloater | 4.78 % | 3.49 % | 18,882 | 19.08 | 1 | 0.1320 % | 3,562.5 |
| Floater | 2.50 % | 2.28 % | 46,352 | 21.56 | 4 | 0.1549 % | 2,588.8 |
| OpRet | 4.81 % | 3.57 % | 59,074 | 2.23 | 8 | 0.0965 % | 2,392.3 |
| SplitShare | 5.31 % | 1.24 % | 287,356 | 0.82 | 4 | 0.0451 % | 2,461.8 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0965 % | 2,187.6 |
| Perpetual-Premium | 5.74 % | 5.50 % | 116,869 | 1.23 | 9 | 0.0110 % | 2,035.8 |
| Perpetual-Discount | 5.54 % | 5.64 % | 132,206 | 14.40 | 15 | 0.0509 % | 2,110.7 |
| FixedReset | 5.24 % | 3.74 % | 170,640 | 3.04 | 54 | 0.0077 % | 2,263.2 |
| Deemed-Retractible | 5.20 % | 5.23 % | 409,744 | 8.27 | 53 | 0.0933 % | 2,082.0 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| CIU.PR.B | FixedReset | -2.08 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2014-07-01 Maturity Price : 25.00 Evaluated at bid price : 27.30 Bid-YTW : 3.77 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| CM.PR.I | Deemed-Retractible | 47,748 | Nesbitt crossed 26,500 at 24.00. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.98 Bid-YTW : 5.25 % |
| RY.PR.X | FixedReset | 34,000 | Nesbitt crossed 16,700 at 17.10. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-09-23 Maturity Price : 25.00 Evaluated at bid price : 27.10 Bid-YTW : 3.78 % |
| ELF.PR.F | Deemed-Retractible | 32,850 | Nesbitt crossed 29,100 at 22.55. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.50 Bid-YTW : 6.70 % |
| RY.PR.E | Deemed-Retractible | 31,449 | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.83 Bid-YTW : 5.08 % |
| CM.PR.L | FixedReset | 31,140 | RBC crossed 25,000 at 27.50. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-05-30 Maturity Price : 25.00 Evaluated at bid price : 27.45 Bid-YTW : 3.49 % |
| POW.PR.D | Perpetual-Discount | 29,570 | Nesbitt crossed 19,400 at 23.05. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2041-02-14 Maturity Price : 22.79 Evaluated at bid price : 23.00 Bid-YTW : 5.49 % |
| There were 33 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| CIU.PR.B | FixedReset | Quote: 27.30 – 27.75 Spot Rate : 0.4500 Average : 0.2933 YTW SCENARIO |
| CIU.PR.A | Perpetual-Discount | Quote: 22.75 – 23.10 Spot Rate : 0.3500 Average : 0.2469 YTW SCENARIO |
| BMO.PR.P | FixedReset | Quote: 26.51 – 26.74 Spot Rate : 0.2300 Average : 0.1551 YTW SCENARIO |
| BNA.PR.E | SplitShare | Quote: 24.58 – 24.99 Spot Rate : 0.4100 Average : 0.3544 YTW SCENARIO |
| HSB.PR.E | FixedReset | Quote: 27.75 – 27.95 Spot Rate : 0.2000 Average : 0.1445 YTW SCENARIO |
| BMO.PR.H | Deemed-Retractible | Quote: 25.20 – 25.35 Spot Rate : 0.1500 Average : 0.0967 YTW SCENARIO |
The Birinyi and Crumb story was reported in the Globe on the weekend.
My only comment is that the S&P-500 is the wrong benchmark for comparison. S&P-500 is cap-weighted, while the 2,700 upgrades and downgrades are (mostly) unweighted.
I’m pretty sure that mid-cap and small-cap indices have outperformed the S&P-500 since March 2009, so it is far from clear that a downgrade is eventually positive when compared to a proper benchmark.
The academic studies usually like to control for size (cap) and book to market — among other variables when discussing relative performance. As a result, I’m not sure this study is clear cut about anything other than the first day results.