Spread risk

[Tipo]

R45.P2.T6.Malz_Ch7_v3

p25
Spread risk is the risk of loss from changes in the pricing of credit-risky securities. It is closer in nature to market risk as it is generated by changes in price

p27
Spread risk therefore encompasses both the market’s expectations of credit risk events and the credit spread it requires in equilibrium to put up with credit risk

Doesnt it seem to contradict each other?
My understanding is that the impact of a firm's credit rating (credit risk events) affects the spread which then generates the change in price. Why is it closer in nature to market risk?

 

[brian.field]

Not sure I understand the question exactly but my gut tells me that spread risk is similar to market risk because it is based on market prices - and more importantly, based on market "expectations" of future credit risk.

 

[Tipo]

Not sure I understand the question exactly but my gut tells me that spread risk is similar to market risk because it is based on market prices - and more importantly, based on market "expectations" of future credit risk.

The question is as it is "Why is it closer in nature to market risk?"

The market price is based on the credit risk. Why isnt it closer to credit risk?
The price is simply the reflection of credit risk

 

[brian.field]

Yes but not actual credit risk. Rather, perceived credit risk, which is market driven. I'll defer to David since I'm guessing more or less.

 

[Aenny]

The question is as it is "Why is it closer in nature to market risk?"

The market price is based on the credit risk. Why isnt it closer to credit risk?
The price is simply the reflection of credit risk

I do not agree with you, taht price is simply refelction of credit risk. thinking of bonds, the price depends not only on the idiosyncratic risk of the issuer but also of systematik risk factors such as tresury rates for example. Credit risk is the risk arising from not paying outstanding loans either due to unwilligness or due to unablility. ( Default, derrreal, etc..). The spread of the bond is mainly driffen by sector, (consumer, etcc), rating grade (AAA/BB, ..) issuer country (UK, US, ..). So of course if the issuer is downgraded the spread reacts accordingly. But also the spread widdens if general the sector is punished due to global forcast. Lets say the market expectation is that consumer branche will profit in the next cycle, then the spreads of that branche will narrow. That addaption will take place on a day-to-day basis and therefore will change quickly. Therefore the spread reacts to global variables much more often and by higher volatility than to only issuere specific changes in estimation. For the last, these changes will also be part of the spread, absolutelly but not the main reson for daily volatility and movement.

I hope that helps