Credit risk management

1. Managing Credit Risk Under The Basel III Framework 175
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CDS Indices
12
KEY CONCEPTS
• CDX index
• iTraxx index
• On-the-run series
• CDS index contract
12 CDS indices
12.1 CDX and iTraxx indices ★★★★★★★★★★★★
Similar to other financial risks, the credit risk of a debt comprises the systematic risk
driven by macro factors common to many debts and specific risk driven by idiosyncratic
factors impacting only that particular debt. For internationally active banks, their debt
investments are largely diversified due to the huge number of debts issued by many
different issuers in the debt portfolio, leaving the systematic risk as the dominating
component. Since systematic risk is not observable directly, effort has been made to
discover this systematic risk. This drives the development of the CDS indices.
Region Credit quality/theme No. of
compo
-nents
Index
North
America
Investment grade 125 CDX.NA.IG
Investment grade and high volatility 30 CDX.NA.IG.HVOL
High yield grade 100 CDX.NA.HY
BB 37 CDX.NA.HY.BB
B 46 CDX.NA.HY.B
Crossover 35 CDX.NA.XO
First lien leveraged loans 100 LCDX
Emerging
markets
14 CDX.EM
Diversified 40 CDX.EM Diversified
Table 12.1 CDX indices
A CDS index is the arithmetic average of the updated CDS spreads of a group of liquidly
traded and standardized single name CDSs (from three to 125 components) that are
originated on specific days in March and September to protect the reference debts issued
by a number of different and representative debt issuers with certain common
characteristics. After the origination, the CDS spreads of this group of single name CDSs
are calculated with respect to the revised premium, subject to the assumption that a new
zero value single name CDS is originated for the original reference debt, having the same
principal, issuer and maturity day but updated LGD, updated PD and reduced protection
period. A CDS index serves as a proxy to represent the systematic credit quality of a
particular segment in the credit market.

2. 176 Managing Credit Risk Under The Basel III Framework
Copyright 2018 CapitaLogic Limited
Region Theme No. of
CDSs
Index
Europe 125 iTraxx Europe
High volatility 30 iTraxx Europe HiVol
Crossover 75 iTraxx Europe Crossover
First lien loan 40 iTraxx LEVX
Non-financial 100 iTraxx Non-financials
Senior subordination financial 25 iTraxx Financials Senior
Junior subordination financial 25 iTraxx Financials Sub
Telecommunications, media
and technology
20 iTraxx TMT
Industrial 20 iTraxx Industrials
Energy industry 20 iTraxx Energy
Manufacturers of consumer
products
30 iTraxx Consumers
Automobile industry 10 iTraxx Autos
Asia Ex-Japan investment grade 50 iTraxx Asia
Ex-Japan high yield 20 iTraxx Asia HY
Japan 50 iTraxx Japan
Australia 25 iTraxx Australia
Country West Europe 15 iTraxx SOVX West Europe
Central/East Europe, Middle
East and Africa
15 iTraxx SOVX CEEMEA
Asia Pacific 10 iTraxx SOVX Asia Pacific
Latin America 8 iTraxx SOVX Latin America
Global liquid investment grade iTraxx SOVX IG
G7 iTraxx SOVX G7
Brazil, Russia, India, China iTraxx SOVX BRIC
Table 12.2 iTraxx indices
The major CDS indices are operated and published on a daily basis by Mark-it.31
These
CDS indices come in two families:
• The CDX family covers the CDS indices for North America and emerging markets;
and
• The iTraxx family covers the CDS indices for Europe, Asia and countries.
In addition to geographical area, CDS indices are also classified by type of debt issuers,
credit quality and standard tenor.32
As such, a number of CDS indices are created to
serve the needs of a broad range of investors. The two most popular CDS indices are:
31
The CDS indices are published by Mark-it on its website with the URL
http://www.markit.com/markit.jsp?jsppage=indices.jsp
32
Standard tenors include one, three, five, seven and ten years.