Counterparty Risk in Exchange-Traded
Notes (ETNs)

Abstract

This article addresses the issue of counterparty credit risk in exchange-traded notes (ETNs). An ETN is a tracking product that is designed as an unsecured debt security and is therefore subject to the issuer’s default risk. The authors use a standard reduced-form pricing framework to gauge the theoretical effect credit risk should have on ETNs. They then derive firm-specific credit risk measures by using real market data to construct model-implied risk-adjusted ETN prices. Their results indicate that a substantial credit risk discount should be priced into ETNs. In sharp contrast, however, based on real market ETN quotes, they found very little evidence for credit risk pricing by market players.