Panel: Lack of Data Hampers Valuations

According to a poll, 78 percent of attendees are not satisfied with the current pricing of structured credit instruments. More specifically, 40 percent blame a lack of information for underlying instruments-such as performance data for loans included in mortgage-backed securities-as the key difficulty in the valuation process.

"This seems to be a European problem and not a US problem. In the US, the market is much better developed... with more standards [around disclosure]," said David Clark, a consultant for the International Capital Markets Association-though he added that the problem cannot be solely attributed to a lack of data, since the credit crisis originated in the US, despite having more disclosure standards.

Another difficulty in valuing illiquid securities highlighted by attendees and the panel is the lack of secondary market liquidity. "I think the single biggest issue is either the unwillingness or the inability of the investor base to price the risk," said Dave Covey, executive director of European ABS research at Lehman Brothers.

"When there is no liquidity... any market price is not going to produce a fair value," Clark said, suggesting a rating scheme for pricing liquidity risk, though Damiano Brigo, global head of quantitative innovation at Fitch Ratings, said such a scheme might prove complicated as liquidity does not necessarily lend itself to technical analysis.

And while firms can use a combination of actual traded prices, consensus quotes, and more liquid index values as a proxy for valuing securities, Clark said it is hard to write a definitive formula to weight each of those factors.

Theoretical valuation models may also need some adjustments, in particular the use of the Gaussian Copula statistical distribution, while sourcing accurate correlation data as an input into pricing models is also extremely difficult for bespoke pools of instruments that are not defined by tranches within liquid indexes. "Nobody believes the model anymore," said Brigo. "The method that the market has come up with to map the correlation of liquid pools to bespoke pools is very dubious."

Collaboration will be key if firms are to improve their valuation processes and the levels of information available in the market, said Meredith Coffey, director of analysis at Thomson Reuters, which is launching a Web site for market participants, academics and valuation specialists to share ideas on common valuation problems.