Anyone got any ideas on how best (preferably simple) ways to calculate illiquidity premiums for private debt/loans ?
Thanks in advacne作者: krause2 时间: 2011-10-3 15:35
protective put
asian put
finnerty
I would use a volatility input for comparable instruments in the public markets - i.e. corporate/high yield issuances.作者: kingstongal 时间: 2011-10-3 15:41
dude, I said uncomplicated!
Basically I have a credit rating for a loan and interest rate price based on that. Now because its not traded anywhere and would be tough to trade anywhere, I want to determine an appropriate illiquidity premium?
Any advice作者: kickthatcfa 时间: 2011-10-3 15:46
It actually is uncomplicated.
How long is your holding period until a buyer materializes? Let's say 3 years
Strike $1
Price $1 (i.e. parity)
Volatility 5 percent (i.e. trading levels vs. par)
Holding Period 3 years
Dividend interest payments (i.e. interest rate)
Oila. Cost of put = illiquidity premium.
Finnerty and asian put models are more complex but also address some nuances.作者: dreampak 时间: 2011-10-3 15:51
Illiquidity premiums on debt instruments are generally pretty low. Save yourself the trouble and just add 25 bp and call it a day.作者: yospaghetti 时间: 2011-10-3 15:57
Do you know a market maker of a private note with no rating not registered with the SEC at a 25 bps spread?
I completely agree that if you have market information on spreads or agent commissions that is 100 percent the way to go. Just wondering where you're getting your rule of thumb from.
Not knocking it, just want to know - that's good info.作者: yospaghetti 时间: 2011-10-3 16:02
Beta Private Wrote:
-------------------------------------------------------
> Do you know a market maker of a private note with
> no rating not registered with the SEC at a 25 bps
> spread?
>
> I completely agree that if you have market
> information on spreads or agent commissions that
> is 100 percent the way to go. Just wondering
> where you're getting your rule of thumb from.
>
> Not knocking it, just want to know - that's good
> info.
I do consulting work for a well know BDC. They typically add 25 bp for their non-traded notes when valuing their portfolio. These are $250 MM offerings though, so a larger premium would probably be applicable to smaller issues. I don't know how much more though.作者: AndyNZ 时间: 2011-10-3 16:08
Well I would guess that is just about as good as info on market stats as you could get. I just wonder how the heck they calculate that. I'm guessing that's ASC 820 stuff, and I can't imagine the auditors are cool with a rule of thumb. I would seriously love to know how they come up with it.作者: therecruit 时间: 2011-10-3 16:13
@ betaprivate, i wouldnt jump into any of these put models here for a few reasons:
1) it's a theory built on shaky academic grounds with many holes to fill in
2) rigorous academic research (if any) and empirical support for such models resides exclusively in the equity space. you cant just transalate any of these results into the fixed income area without substantial modifications and additional support
3) even if you could, it certainly wouldnt happen in the simple way you outlined above. you are pricing some sort of put option where the underlying is a bond with black-scholes, thats like doing brain surgery with a meat cleaver. you'll need to formulate it as a call option where the underlying is interest rate and apply a mean-reverting model such as Vasicek instead of simple GBM
4) what the heck is a "holding period" here anyway? there are no absolute trading restrictions on the bond, just large bid-ask spreads but you can in principle sell it at any time, even tomorrow
5) finnerty and asian put, isnt that one and the same
@transferpricingcfa, your best bet is dig out some empirical data and dont touch any of this "theory". however, i think that in general for bonds it is very hard to separate credit risk premium from illiquidity premium. Longstaff has some work on the subject but i dont think there is anything conclusive. if your benchmark issues are far more liquid than the instrument you are pricing, higgmond's approach of adding a few bp and calling it a day might be your best bet
Edited 1 time(s). Last edit at Tuesday, April 19, 2011 at 01:19PM by Mobius Striptease.作者: mar350 时间: 2011-10-3 16:19
Mobius:
To his point:
>>> dude, I said uncomplicated!
So that's what I threw out there. I agree all those theories have holes in them and have been discussed more in the equity domain. The other comment on interest rate calls and mean reversion is also interesting. Can you explain that more? The math on that? Frankly I don't do much fixed income work so I'm just curious.
It is indeed a true cost of illiquidity, not marketability, since there are no restrictions. Still, the 25 bps just doesn't pass the gut check for me if you're really trying to figure out the fair market value of the note. Could you really find a buyer for a transaction cost of 25 bps? That sounds really low to me.....作者: anshultongia 时间: 2011-10-3 16:24
Thanks for the answers so far guys, but...
How about this,
A comparison of yields on a risk free liquid bond with an equivalent position in corporate bonds protected against default risk using CDS.
liquidity premium = corp bond spread - CDS premium??
So its like comparing a liquid risk free bond against an illiquid risk free bond?作者: yodacaia 时间: 2011-10-3 16:30
@transferpricingcfa
you are implicitly assuming that there is no liquidity premium in the CDS market which is not true, there are large bid-ask spreads there and certain tenors wont trade at all or very rarely. there are academic studies attempting to quantify what portion of the CDS premium is pure default risk premium vs. illiquidity premium, with limited success. so you've just shifted your problem from "illiquidity in bond markets" to "illiquidity in CDS markets" without finding an answer unfortunately
@betaprivate
i agree with you that simple is good (if thats what you meant)! the reason why i wouldnt use these models in fixed income setting is not because they are too simple (or too complex), i just dont believe they produce anything more reliable than randomly adding a spread (of 25bps if you will) - even though they have the appearance of being so quantitative. they are a bit more trustworthy in the equity space cause more research and empirical support was done there, but only by a small margin...作者: NakedPuts 时间: 2011-10-3 16:35
I see your point mobius and agree. never thought of that...
OK Take 2,
How about using covered bonds?
Liquidity premium = covered bond index yield - swap yield ?作者: jacksparrow 时间: 2011-10-3 16:41
Yeah, all the theoretical models are ultimately crap given all the inputs are really subjective to a certain extent anyways, just have to look behind another curtain to find the one pulling the levers.
I like where the other conversation between you guys is going though - good stuff.
