Accounting fears drive structured credit initiative

Prompted by fears that new accounting standards may prevent banks recognising credit correlation trading revenues, JP Morgan Chase and Morgan Stanley have accelerated development of a structured credit component to their suite of Trac-x credit indexes. ‘Tranched Trac-x’ will take the form of a standardised tranched derivatives contract linked initially to the US Trac-x portfolio, and will be launched simultaneously with the rest of the suite in July 2003, with European products expected to follow.

The original impetus behind the new indexes was a growing unease among dealers regarding default correlation. Rating agencies and issuers of synthetic collateralised debt obligation (CDO) tranches and portfolio derivatives tend to use standard portfolio models – such as the Moody’s KMV Portfolio Manager – in pricing and ratings. These models typically use empirical, bivariate asset correlations as inputs. A simple copula calculation generates expected default times for the portfolio