Today in Visual Display of Quantitative Information (Nerdy)


Zero Hedge points out this awesome chart in an otherwise kind of back-test-eriffic Stanford paper on credit-equity correlation trading:

The chart graphs 2003-2010 investment grade credit spreads (left axis) versus the S&P (bottom axis), with the size of the circles corresponding to the level of the VIX volatility index and the colors distinguishing the year of the observations.

ZH's take:

For all who trade across asset classes, not focusing on just equity or just fixed income, [the paper] contains what is arguably the coolest time series chart looking at the relationship between credit, equity and volatility. While it will have virtually no impact on one's trading prowess, the following correlation between CDX IG, the S&P and the VIX provides countless hours of fun gazing into the distance, as well as numerous probabilistic extrapolations into the future.

True! Also, it's sort of a neat encapsulation of the last 7 years in the markets. If you stare into the eyes of the psychedelic correlation dolphin, you can make out (among other things):

1. A reminder of how unusually stationary SPX/CDX is over this period. The authors of the paper note:

Another important observation is that the slope of CDX.IG as a function of SPX changes over time and over different market conditions. The time-varying relationship is expected, since credit spread is fundamentally a stationary process, while the equity index is obviously non-stationary. This time-varying relationship makes it difficult to directly use the slope as the hedge ratio in the credit-index index arbitrage.

Which is why it's a dolphin instead of an eel - you'd normally think of credit spreads as mean reverting and equity as upward drifting. But still - the noticeable overall shape/slope does drive home the fact that if you put $1 into stocks in 2003 you'd have, oh, just about $1 in 2010.

2. A puzzle on implied vol levels in crappy markets - 2009 saw lower SPX and similar IG credit spreads to 2008 but with 20-40 equity vol rather than 50-80. (Quibble with the dolphin: with most VIX readings in the 10-30 range it's kind of hard to tell them apart.)

3. Simplistic but intuitive visual evidence for an equity/credit disconnect during the crisis (and its closing or even reversal more recently) - the dolphin's lower fin is a reminder that the pre-crisis markets paid up much more for IG credit for a given equity level than they did post-Lehman.

The paper tells you how to follow the dolphin to riches, if you're a big fan of data mining and love math much more than I do.

The Definitive SPX-IG-VIX Time Series, Cross Asset Arb Chart [ZH]

Capital Structure Arbitrage-Implied Index Trading [Stanford]


Today In Swiss Banks With Creepy But Defensible Structured Products

I don't really understand it but the TVIX thing is creepy fun. If you haven't followed it, Credit Suisse issued this exchange-traded note called TVIX that was a 2x levered bet on the VIX. They suspended new issuance about a month ago due to position limits, and people were just so damn excited to own the thing that its price crept up to 189% of its fair value, where "fair value" is a reasonably easily measurable thing based on the formula in the TVIX prospectus. Then last week Credit Suisse announced that they would be creating more units, and the price plummeted to and then through fair value, which is what you'd expect to happen. Except that it started plummeting a few hours before that announcement, which is Suspicious. So of course people are sad and so there's a Bloomberg Brief with sort of sad-funny quotes like: “When it started to fall, I bought more because I couldn’t believe how low it was going. I didn’t realize I was playing with a hand grenade.” – Michael Gamble [heh! - ed.], 67, who doubled down on his TVIX investment before the price collapsed. Investors “all think: ‘Oh, I’ll just buy these things, I’ll be hedged against volatility and everything will be wonderful.’ And now they’ve seen the market goes down and their volatility protection goes down too, and they’re going ‘Hmm, what happened here?’ These people are going to have to pay a really expensive lesson.” – Larry McMillan, who manages $30 million as president of McMillan Analysis Corp. So, yes, Larry, they are going to pay a really expensive lesson. But what is it? Stephen Lubben has a little thing in DealBook today where he frets: