I just read an ISDA press release saying that the J.P. Morgan CDS Analytics Engine will soon be open source. I hope it’s true because I’d love to feast my eyes on that code base.
For the uninitiated, CDS stands for Credit Default Swap. Put simply, a CDS is an insurance contract between two parties that references some financial contract, such as a bond. The party selling insurance receives payments from the buyer every quarter. If the referenced entity (bond) defaults, the quarterly payments immediately stop, and the insurance seller pays out a large lump sum to cover any losses.
CDS contracts have a value that fluctuates with variables such as time, interest rates, and the perceived risk of default on the referenced entity. As a result, there is a large, liquid market for these derivative contracts. A single contract is typically written to insure a notional of $10, $20, $50, or $100 million. Despite dealing with sums that large (or larger), there is no reference, open source pricing mechanism.
Said another way, if a bank or hedge fund wants to value one of its CDS positions, there’s no reference, open source pricing algorithm. Instead, each desk might use an expensive, commercial library, or the CDS pricing screen on their (expensive) Bloomberg Terminal, or their own proprietary pricing algorithm. The standard pricing model within the Bloomberg Terminal is their “J.P. Morgan model,” the details of which are only described at a high level in a one page document. You can’t access the code.
At a previous job I wrote a proprietary CDS pricing algorithm. I was shocked at how subtle variations in the algorithm produce signficantly different results. Furthermore, it’s impossible to tie out your results exactly with a standard such as Bloomberg’s pricer. And I’m wasn’t alone. I spoke to quants at other banks and to vendors who sell their own pricers, and none of them were able to exactly match Bloomberg’s pricer! I had a conspiracy theory that Bloomberg made their pricing output cryptographically secure so that traders would be forced to pay for their CDS pricer.
So if this J.P. Morgan code has any relation to the elusive code within the Bloomberg CDS screen, I can’t wait to see it.
