Where’s exactly the driver of change in loan risk

Changes in implied equity volatility as well as in implied ratings are potential warning signals for absolute return portfolio managers that something is wrong. It might not be obvious what the problem is exactly. But at this stage this is not of utmost importance. This can be left to the analyst. It just indicates that portfolio risk as such is going up and the portfolio manager has to adjust the risk calculations accordingly. In addition to that changes in implied ratings point to where exactly the driver of this change in risk is. Note that risk adjustment does not necessarily result in a reduction of the position that triggered this action. The portfolio manager might, for example, reduce another position he wanted to sell anyway for different reasons, especially when the triggering position is not very liquid and the portfolio manager does not want to sell it below its fair value. So he diverts to another position in the portfolio which allows for a risk reduction at lower cost. Our example gives some wellknown examples of rapidly deteriorating credit quality. They show how fast implied ratings react compared to agency ratings.

Where’s exactly the driver of change in loan risk

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