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To track what is going on in the subprime market and to understand what

the market knew, what market participants knew in 2007 we're

gonna look at a very specific index, and this index is called the ABX.

Asset backed and then X which just stands generically for index.

The ABX has many different types.

Tracking many different types of securities.

The specific one that we will look at is the ABX-HE which stands for home equity.

But really just people refer to it as the ABX because it was by far

the most popular.

It's an index of credit default swaps, the acronym there being CDS,

written on subprime mortgage securitizations.

The price of the ABX index is essentially a measure of the perceived value of

subprime securities with various ratings.

Or the return, or spread, on the ABX,

as it's sometimes quoted, is essentially a risk premium for subprime.

The details of how the ABX is constructed are not crucially important for

what we're going to do.

Really all you have to know is there are many

firms out there that are writing insurance on subprime securitizations.

So somebody bundles together a whole bunch of subprime loans,

sells it out into the market.

And then if somebody wants to write insurance, wants to say,

well how will I be protected if there is actually default on these bonds, then

there are various financial institutions that will write that type of insurance.

And what the ABX does is average those prices across all the different dealers

and tell you this is how much it costs to insure in a sub prime market.

And they do this for

five different ratings from Triple A down to Triple B for the securities.

So what we can do when we look at an ABX index is just get a sense of what

the market thinks about the riskiness is of sub prime securitizations.

Of securities that are collateralized by subprime mortgage loans.

The index was created by a firm called Markit.

And it was first released in January 2006, covering the 20 largest

subprime securitizations that closed in the last six months of 2005.

So the ABX-HE2006-1, which is a mouthful.

Is the ABX home equity index that was first released in the first month of 2006.

Based on securitizations that had taken place over the previous six months.

So when you look at what's going on in the 2006-1ABX.

You're getting a sense for what the market thinks of securitizations of sub prime

mortgages that were written in the last six months of 2005.

Subsequent releases were denoted 2006-2, which are, which came out in July of 2006,

and took the 20 largest securitizations from the first six months of 2006.

The 2007-1, which covered the last six months of 2006,

and the 2007-2, which covered the first six months of 2007.

At that point, subprime activity really slowed down tremendously,

and it was simply too small for any further index construction.

But what made the ABX really interesting is that all of a sudden everybody

could see.

Because there was a public price what the market thought about subprime.

So in 2005 there is really no way to do it unless you talk to somebody who themselves

was looking very carefully at default and was writing the CDS protection.

This is not a public number.

Now we have a public number.

The Wall Street Journal can write about it.

All market participants even if they're not specialized in this area

can learn what's going on in sub prime.

So this in some sense enables us to track the market's

expectations in a way that we could not do before.

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Lecture: ABX

The Global Financial Crisis

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