Emergence of Default Swap Index Products

By J.Duffie, Erin Yurday
2004 | Case No. F268
With the increased liquidity in markets for credit derivatives around the turn of the century, coupled with dramatically increased corporate default rates, fixed-income investors and buyers of credit protection were receptive to a new generation of structured credit products that would further enhance their abilities to efficiently transfer credit risk, especially products offering improved liquidity and diversification. In April 2003, Morgan Stanley partnered with JPMorgan to co-market and co-design a suite of credit indices. Their first product, named TRAC-X, was a portfolio of underlying single-name credit default swaps. To enhance liquidity and make TRAC-X the new benchmark for credit trading, Morgan Stanley and JPMorgan offered to make two-sided markets (subject to market conditions) at bounded bid-offer spreads, and licensed TRAC-X to other dealers. In early 2004, Lisa Watkinson was the executive director and global product manager for credit default swap and credit indexation products at Morgan Stanley in New York, responsible for the development and marketing of all credit derivatives and credit indexation products globally. Recently, the TRAC-X products had faced criticism in the market, and, opportunistically, competing basket credit products had been launched. While Morgan Stanley was still at the leading edge of an explosive and profitable line of structured credit products, Watkinson faced significant business development risk, trying to maintain the liquidity associated with her first-mover advantage. Liquidity was important for its own sake, in addition to promoting trading opportunities and revenues. The market for credit derivatives was changing dramatically, and Watkinson was trying to stay ahead of the competition for order flow by responding to client needs and adapting her products quickly (including ceding product control to Dow Jones and developing a futures market).
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