Figure 3

One goal of this type of analysis is to determine if there is a common set of parameters that will price the entire credit curve. In this case the correlation lines intersect near a peak CDR of 11% and a correlation of 13%. The distribution for these parameters is the one shown in blue in figure 2. It is interesting to note, however, that the distribution implies a 15.5% probability of losses exceeding 7%, which is the point at which the CDS begin to show shortfalls. The distribution for the 18 peak CDR, with a correlation below 2% and a life time loss over 5%, is shown in purple.

Based upon this analysis, ABX 06-2 is being priced by the market with an expected life time loss of under 4% and an asset correlation of 13%. The expected losses are above 5% when assuming a significantly lower correlation. A lower correlation, which has some theoretical and intuitive appeal, would imply that the A and BBB bonds were cheap relative to the BBB- bond.

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