Increased liquidity in credit-default swaps, spurred on by the growth of credit derivatives indices, is decreasing the flexibility of trade documentation. Simon Meers, senior v.p. at ACE Financial Solutions, noted that while liquidity brings benefits, end-users have lost some ability to structure trades according to their specific risks. Confirmations have become standardized, he added.
Correlation assumptons for single-tranche CDOs are also problematic because no-one can really define the variables going into the Monte Carlo-based models that are used to determine prices on the trades. Mark-to-market pricing of the tranches is also problematic for end-users which, unlike the dealers, don't see everyday trading flow and this makes it difficult to understand large shifts in value. A solution, however, may be constant-maturity swaps and options on credit derivatives because they can overcome much of the mark-to-market volatility.
