Pricing Brazilian ABS to Trade in the Secondary Market: Benefits from Assimilating Best Pricing Practices

Abstract

Brazilian asset-backed securities (ABS) appeal to investors because of their relatively high yields and diversification benefits. However, Brazilian and international investors struggle to price these ABS because of the country’s unique financial calculations, lack of transparency, and the scarcity of quantitative pricing tools in Brazil. Even Bloomberg presents these securities with analytical tools for mutual funds rather than for typical ABS. Brazil’s lack of standardization with respect to calculations and documentation compounds the pricing problems. This forces pricing tools to use more-complicated algorithms and pricing models. The authors show that this extra work is worth the effort. Arbitrage-free pricing models provide more insight into the potential returns and risks embedded in the shares (tranches) of a Brazilian ABS. They also propose norms for standardizing the information needed to trade in secondary markets for Fundos de Investimento em Direitos Creditórios (FIDCs—the most prevalent ABS vehicle). All market participants would benefit from the increased liquidity and capital flows that would result from adopting the best practices for pricing described in this article.