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Derivatives

GM, Ford Downgrades Fail To Kick Start Recovery Mart

The recovery swaps market got a small boost after the downgrade of General Motors Corp. and Ford Motor Co., as some protection sellers sought to hedge their exposure to recovery rates in the case of an eventual default.

The recovery swaps market got a small boost after the downgrade of General Motors Corp. and Ford Motor Co., as some protection sellers sought to hedge their exposure to recovery rates in the case of an eventual default. But the downgrades failed to kick start the market because most traders focused on first-order exposures such as credit spreads.

According to Greg Tell, a director and head of North American credit options and exotics trading with Barclays Capital in New York, speculators have not actively traded recovery because volatility of recovery assumptions is too low. He explained these swaps are more often used for matching up hedges of two positions with different natural recovery exposures, like interest rate swaps and credit-default swaps. But even when volatility picks up, as was the case following the auto downgrades, traders focus on CDS, not putting together a fine-tuned trade. "When markets get chaotic, everyone becomes a credit-default swap trader," he said.

Another credit trader agreed credit spreads were the first order of business following the GM and Ford downgrades, but said recovery swaps trading will pick up once things settle down. He expects the recovery market to take off in the next few months, especially after the GFI-led initiative to standardize the market by trading a single recovery instrument wraps up (DW, 2/21).

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