Q&A: CDS Rules - WSJ.com
Question: Shouldn't we just the market self-regulate?
Answer: However, we do find it worthwhile to regulate the insurance industry - at least to a prudent extent with respect to things like life insurance. Here the buyer of policy has to has an "insurable risk". If this wasn't the case, and an insurance company has to issue insurance to those who wanted to "bet" on the life of another, it would be hard to use sound actuarial tools to estimate risk.
As such (and one could go on and on here), it would seem as though those who really wanted to protect themselves with credit insurance should be able to do so with a counterparty with full information (i.e. an insurable risk).
In the uncovered risk area, it is more like shooting craps in that the ability to increase the risk increases the potential reward; but, an earlier seller might not have knowledge that his risk will be increased by future events. As such, pricing could become much more distorted in terms of the CDS fulfilling a true business function.
The flip side is of course Basel II type regulations which remove a lender's responsibility to make prudent business decisions by turning everything into a process - which, in the case of AAA sub-prime paper blew up. But, no one who bought the stuff was thinking. They just knew the benefits of the credit rating and that's where smarts stopped.
Thursday, March 11, 2010
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Should we ban people in the stock market from buying "naked" put options? How does that really differ from CDS?
ReplyDeleteAs someone who writes puts quite often I will tell you that pricing them satisfactorily is quite possible.