Credit Risk Mitigation Warrant Market And CRMW Pricing

In the21st century, the rapid development of credit derivatives has become the mostinnovative derivatives on the international financial markets.Since the launch of pilot business ofcredit risk mitigation instruments (CRM), the credit derivative market with Chinese characteristicshas formally started. CRM includes credit risk mitigation agreement (CRMA) and credit riskmitigation warrant(CRMW). Credit risk mitigation certificates is created by the entity except thesubject entity, it is to provide the underlying debt on credit risk protection for the certificate holder,and it is also tradable certificates in circulation. It is because of these structural design of CRMAand CRMW, CRM is also known as the Chinese version of CDS. CRMW core function is tomitigate credit risk, and to provide effective credit risk management tools for market participants.CRMW’s launched during the period of pilot business have relatively shorter maturities.Those warrants are written on underlying obligations including MTN and CP, with both theunderlying entities and underlying obligations rated above AA. Secondary market for CRMW arehighly illiquid due to the low acceptance of market participants, as well as the reason thatCRMW’s are generally undervalued. Dealers involving CRMW’s launch and transaction includecommercial banks and securities companies, with mutual funds and insurance companies excluded,for the disagreements among regulators. Under reduced form model, CRMW can be effectivelyvalued, with credit curve bootstrapped from market yield data. This paper analyzes the productcharacteristics CRM market, deal flow, market reaction and the distribution of the participatinginstitutions, especially for CRMW for analysis, and in the secondary market trading in circulation8CRMW credentials pricing theory, analysis of the most important factors that influence pricing andthe reasons for the low quote CRMW creation. Key factors for CRMW pricing are properly chosenof credit curve and estimation of recovery rate for underlying obligation. Empirical results confirmthe market consensus on undervaluation of CRMW.