Investing in credit derivatives

Abstract

The ongoing turmoil in the United States sub-prime mortgage market - and, more recently, the sub-prime mortgage-related losses being reported by some of the worlds largest banks - have brought into sharp focus the risks of investing in credit derivatives, even where the credit derivatives are not linked predominantly to subprime mortgages but, instead, cover apparently diversified pools of mortgages and other bank loans (Economist 2007). The obvious credit risk associated with subprime mortgages and the losses that have eventuated when, as expected, many of these mortgages defaulted or could not be re-financed have, however, taken many investors by surprise. Yet this element of surprise is p..