CDSD Settlement Pricing via Dynamic Weighting
Find Innovative SolutionsGenerate Solutions
Solution Overview
Problem
Existing systems face challenges in determining settlement prices for credit default swap deliverable (CDSD) contracts after a credit event, leading to illiquidity and reliance on bond trading, especially when there are more contracts than bonds available, which complicates pricing and trading.
Innovation Solution
The implementation of a system that determines a settlement price for CDSD contracts by calculating a function of iteratively adjustable weightings, upfront prices, and bond prices, using a method that adjusts the proportion of settlement price attribution over time to reflect market conditions and availability of bonds, facilitating trading before the auction date.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Reliability
If settlement prices are determined using traditional bond trading methods, then pricing can be obtained when bonds are available, but liquidity is reduced and trading is hampered when there are more contracts than bonds available
Solution Approach 1:
The patent introduces an intermediary pricing mechanism that uses a basket of bonds as a reference to determine settlement prices for CDSD contracts. When direct bond trading is insufficient, the system uses the basket bond price as a mediator to calculate settlement prices through a formula that incorporates both the basket bond price and upfront price, ensuring continuous pricing without requiring actual bond transactions for every contract.
Solution Approach 2:
The patent changes the pricing parameters from relying solely on actual bond trading prices to using a composite formula that includes basket bond prices, upfront prices, and weighting factors. This parameter transformation allows the system to generate settlement prices even when bond liquidity is low, by adjusting the weighting between different price components based on market conditions.
2Measurement precision
If reliance is placed on bond trading for pricing, then actual market transactions can be captured, but pricing becomes complicated and trading efficiency is reduced when bond availability is limited
Solution Approach 1:
The patent segments the pricing mechanism into distinct components: basket bond price, upfront price, and weighting factors. Each component serves a specific function in capturing different aspects of market conditions. This segmentation allows the system to maintain measurement precision by incorporating multiple market indicators while managing complexity through modular calculation steps.
Solution Approach 2:
The patent creates a universal pricing formula that can handle multiple scenarios: when bonds are readily available, when bonds are scarce, and at different stages before the auction date. The same formula structure adapts to different market conditions by adjusting weights, providing a multi-functional pricing mechanism that reduces complexity compared to having separate systems for different scenarios.
3Measurement precision
If settlement prices are determined close to the auction date, then auction outcomes are better reflected, but liquidity and trading facilitation are reduced
Solution Approach 1:
The patent implements dynamic weighting factors that automatically adjust based on the time remaining until the auction date. As the auction approaches, the weighting shifts to reflect auction outcomes more closely. This dynamic adjustment allows the system to extend the trading window and maintain liquidity early on, while progressively aligning prices with auction outcomes as the deadline approaches, resolving the contradiction between early trading facilitation and accurate outcome reflection.
Data Source
AI summary
Methods, systems and apparatuses are described for determining that a credit event has occurred for an entity; determining an upfront price and a bond price for a credit default swap deliverable (CDSD) contract associated with the entity; determining a first weighting for the upfront price and a second weighting for the bond price; and calculating a settlement price for the CDSD contract that is a function of the first weighting, the second weighting, the upfront price, and the bond price.