What is Risk Repricing?
Risk repricing, or risk based repricing, is a market process similar to price corrections; but here correction takes place according to the risk of holding a security. Risk repricing usually occurs in/at the end of a long bull or bear market. Strong market movement in one direction can lead to poor estimates about the risk of holding a stock or bond. As risk should match return, an eventual repricing occurs which can be noticed by widening or tightening of the spreads.
The basic idea behind risk repricing is that different instruments have different levels of risks and high risk investments offer higher returns. The risk of holding/trading a security is determined by many factors such as its price, liquidity, historical performances, future performance expectations, and other economical, political and natural factors. Often, this risk is poorly estimated. For example, in a strong bull market a high risk stock of a company can be as liquid as a blue-chip stock; the price can rise quickly and with tight spreads. But once investors realize that this stock holds more risk (or when they get poor returns), risk repricing can occur which is evident by the declining prices, widening of spreads, low trading volume/low buying demand.
One recent example of risk repricing occurred during the 2007 subprime market fall, when investors realized that the mortgage backed securities (MBS) were riskier than they had believed them to be. This led to the demand for higher return (risk premium), and widening of spreads. As the financial performances of these securities are at doubt and as their valuations do not justify their risks, the downward repricing started.
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The basic idea behind risk repricing is that different instruments have different levels of risks and high risk investments offer higher returns. The risk of holding/trading a security is determined by many factors such as its price, liquidity, historical performances, future performance expectations, and other economical, political and natural factors. Often, this risk is poorly estimated. For example, in a strong bull market a high risk stock of a company can be as liquid as a blue-chip stock; the price can rise quickly and with tight spreads. But once investors realize that this stock holds more risk (or when they get poor returns), risk repricing can occur which is evident by the declining prices, widening of spreads, low trading volume/low buying demand.
One recent example of risk repricing occurred during the 2007 subprime market fall, when investors realized that the mortgage backed securities (MBS) were riskier than they had believed them to be. This led to the demand for higher return (risk premium), and widening of spreads. As the financial performances of these securities are at doubt and as their valuations do not justify their risks, the downward repricing started.
NobleTrading.com Offers Online Stock Trading, Online Options Trading
Online Futures Trading, Online Forex Trading
Worldwide Brokerage Service, Day Trading Brokerage
posted by Daniel Pipitone at
6:25 AM
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