BP and the vortex of fear | FT Alphaville

BP and the vortex of fear

With BP’s share price taking another beating on Monday – it finished 9.3 per cent lower in London – JPMorgan has been drawing clients’ attention to cross current circularity – a situation whereby equity and credit markets look at each other for pricing information, apparently

Now, this is important, the bank says, because there is a risk a lower BP share price triggers a higher CDS spread and vice-versa as each security re-prices off the other, potentially creating a self feeding vortex of fear.


Indeed, that’s already started to happen, according to analyst Fred Lucas, who has an overweight rating on BP.

Investors must beware cross-capital market circularity – In these extreme situations characterized by unprecedented sudden demand for default protection and acute news headline risk, we feel that there is an inevitable risk of circularity connecting BP’s share price and its CDS spread. Indeed, we measure a negative correlation of -0.9 between BP’s share price and its CDS spread since 20 April (figure 1).

Figure 1.

And Lucas says this is wrong because CDS market is probably overreacting.

CDS pricing has very likely over-reacted given the surge in demand for default protection in a name where such demand was virtually non-existent prior to the Macondo incident. Such demand has been sourced from both bond and equity investors and, we understand, much of this demand has been algorithmic-type correlation trading (i.e. initiated by models that send default protection buy orders as the spread widens; CDS re-pricing has been similarly influenced).

Somehow though, we don’t think the market is listening. Still, a nice try.

BP shares closed at their lowest level since March 2002 today. While its CDS was last quoted at 435bps, up 48 on the day.

Related links:
For BP, breaking up is hard to do – FT Alphaville
Svanberg under scrutiny at BP – FT
BP short interest, other facts and stuff – FT Alphaville
Beyond patriotism – FT Alphaville
The ‘Sinofication of BP’: Thinking the unthinkable – FT Alphaville