Nomura Securities has updated its internal credit correlation model and is considering offering advisory services to clients to help them assess positions in their correlation books. The model, which now deploys the so-called gamma/phi pricing method, takes greater account of the possibility of large credit spread movements and also how quickly spreads may move. Martin Baxter, director of quantitative research in New York, said this is an improvement on the standard base correlation model and the firm has been running it since August to price new collateralized debt obligations.
Nomura has not noticed any major price changes in its own book. But its model is indicating that mezzanine protection is overpriced right now and this may mean that players that have been hedging the spread-tightening effect of constant proportion debt obligations by buying mezzanine protection and selling equity (DW, 11/20), may be paying over the odds.
Since the May 2005 correlation crisis the search has been on for a model that would better predict the impact of large single-name movements on tranche pricings. Rivals said Nomura is the first to reveal it is using a new model, but they noted most houses have been working on improving models for the past year to include the same approach.
