I’ve been following GM’s progress over the last six months, and I thought I would have a look at what the market thinks they will do over the next year
Firstly, looking at a simple pricing model for Credit Default Swaps (CDS) - the risk-neutral probability of default using a binomial model
γ0= s0/((1+r0+s0)*(1-RR))
where
s0 = CDS premium
r0 = Interest rates
RR = Recovery rate
Some assumptions:
Using
s0 = 1400bps (USD, MR restructuring)
r0 = 4%
RR = 38%
Gives a value of 19.1%, so this tells us that in (simplified theory), the markets believe that GM has around a 1 in 5 chance of defaulting within the year.
This number seems very high - historical data suggests that the chance of a BB rated bond is around 1.3% and B around 6.6%
The article below investigates why that may be the case
http://www.bis.org/publ/qtrpdf/r_qt0312e.pdf
References:
Credit Derivatives - Gunter Meissner - Page 104
http://www.amazon.co.uk/exec/obidos/ASIN/1405126760/qid=1144335586/sr=1-1/ref=sr_1_0_1/203-2251018-4885533
Attached spreadsheet:
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The opinions expressed herein are my own personal opinions and do not represent my employer's view in any way.
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