Chart of the Day – Argentinian CDS, A Case Study in Market Jumps

Argentina is close to defaulting on its dollar-denominated debt.  Again.  It defaulted in 2001, in what was then the largest sovereign default in history (now surpassed by Greece).  After a very interesting set of court rulings over the past 6 months, which should provide years of stimulating fodder for legal buffs, it looks likely that Argentina will default again within the next month.  Felix Salmon has done a fantastic job covering the details of this court battle – a good summary here most recently.  (For those interested in the long backstory, Mr. Salmon has good coverage here, here, and here)

Though I’m fascinated by the details of the story as someone who has traded sovereign CDS in the past, it’s not relevant for the vast majority of financial market participants.  But I wanted to bring up the CDS (credit default swap) chart for Argentina as a good lesson in financial market nonlinearity.  Here is the 3 year chart of 5 year CDS on Argentina:



Argentinian 5 year CDS traded between 500 and 1500 for most of the past 3 years.  In layman’s terms, a default within the next 5 years was viewed as a relatively low probability event.  However, over the past month, the price of that CDS has skyrocketed, touching 4000 at one point in intraday trading today, and now back down to around 3000, still triple the price of CDS a little more than one month ago.

In other words, in less than a month, the market went from a no-default expectation to a default expectation.  I bring this chart up today as an illustration of how jumpy financial markets can be, particularly on new, incremental news.  Sure, the CDS jumped on the court ruling.  But clearly, the market had previously badly mis-priced the likelihood of such an event.  Many financial markets are prone to such mis-pricing, and it’s why you will routinely see stocks move 20-40% in one gap move.

As a result, expecting the unexpected is a crucial trait for any trader.  Just ask anyone who sold Argentinian CDS a month ago.