Risk Premia Strategies - Credit Markets
The Art of Selectively Harvesting Attractive Risk Premia
CREDIT CARRY STRATEGY
Carry strategies, or long credit strategies, consist in either purchasing bonds or selling CDS protection, which is a standard premium strategy. A buyer of CDS protection will receive a credit spread in compensation for the default risk of the reference entity he takes a position in.
For a bond holder, the credit spread may be defined as the additional yield an investor receives for a security with credit risk over the risk-free yield.
The credit spread of an instrument is, in general, significantly higher than the expected value of the potential loss and offers a risk premium reward to the investor. It can be broken down into three main components:
Long credit has been one of the better performing strategies in recent years. Moreover, the search for yield in a current low interest rate environment, coupled with low default rates has boosted investors’ appetite for high yield names in credit markets.
CREDIT MOMENTUM STRATEGY
QMS Advisors' credit momentum strategy makes use of a standard signal processing technique known as the Kalman filter. This statistical technique allows for splitting the credit spread time series into two components, a momentum and a mean-reversion component. Trading rules are defined depending on the level of these two components.
As one would assume, the above momentum strategies performed best when spreads move sharply in one direction, either on the upside or on the downside and the performance is more limited when the market is range-bound.
These sources of risk premia cover strategies based on credit spread scoring models that are designed to generate alpha performance in credit markets. They aim at estimating the fair value of credit spreads based on fundamental and market indicators. Their principle is to implement long/short CDS strategies based on credit spread valuation models that buy (sell) protection on the 20 tightest (widest) names relative to the model.
Risk Premia - Credit
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