New research by MSCI suggests that Russian stock prices may not have the same value as those listed on Moscow Exchange.

Moscow quit trading as stocks fell on account of Russia’s invasion. reopening a month laterThe exchange was shut down for the second time in its history, since the fall the Soviet Union. International powers have also taken away the Moscow Exchange’s recognition status.

It MOEX Russia IndexThe Russian stock market is now down by more than 36% for the year to Friday afternoon. Since then, international investors have had restrictions on managing their assets and valuing them.

MSCI, which links stock and bond markets said Friday that the market for credit default swaps suggested that Russian stocks may be “essentially worthless”, contrary to prices on the exchange.

Credit-default Swaps allow investors to trade their credit risk against a country, company or entity with other investors. Lenders purchase CDSs from investors in the understanding that they will pay the investor if the borrower defaults.

According to Friday’s MSCI report Zoltan Sass, Senior Associate at MSCI, “The discrepancy between the CDS markets and listed prices for Russian stocks could be due to technical-default fear and failure of the CDS Auction mechanism, restrictions trading CDS related to securities of sanctioned businesses and lower perceived value Russian equity to CDS investors.”

This model assumes that defaulting on debt will happen if the stock price of a company falls to zero. MSCI explained that a company’s default risks are determined by how much it is worth relative to the amount of its debt.

This concept-based models can be used to compute default probabilities from share price, but they also have the ability to infer equity prices using default probabilities. MSCI analysts made this possible in Friday’s research paper.

Since the Russia-Ukraine war, trading in Russian corporate CDS is on the rise. An increase in trading activity could indicate that CDS markets contain information unavailable to the equity market. Sass explained that the research uses CDS market implied default probabilities in order to calculate Russian equity prices.

MSCI data revealed that while Russian stock prices have fallen by 36% in the aftermath of the invasion, CDS markets were virtually unchanged when the prices aligned.

The basic reason for this disconnect is investors who trade on one market but not the other. Sass said that Russian stock trading is not possible for most foreigners, while CDS are available only to institutional investors.

Market distortions

Researchers also discovered that the results of the model could be due to distortions in CDS markets caused by Russia and Ukraine war. The underlying bonds must be sold if a CDS default results in a payment.

Sass stated that difficulties in transferring bonds may be caused by market frictions or sanctions. This could increase the CDS implicit default probability and the premium for default protection.

“Also, sanctions can cause impediments to bond payments that could result in a technical default. The firm may not be technically bankrupt but cannot pay principal or coupons because of these obstacles.”

Russia’s markets are tightly restricted so all market areas have experienced some distortion. Sass pointed out that MSCI considers the disconnection between stock and CDS stocks to be “striking”. This could indicate divergent valuations due many factors.

Russian companies could continue to exist, pay dividends and generate revenue, so they might still be worth something to the few investors that can afford to invest. Sass stated that Russian stocks are worthless in the eyes of CDS investors.

“This loss of value might be indicative of technical default fear, failure in the CDS Auction Mechanism, restrictions on trading CDS related to the securities sanctioned companies and a lower perceived Russian equity’s value for CDS Investors.”

While he said that Russian markets would be reopened and integrated, as well as the economic recovery, greater price consistency could be possible. He also suggested that investors should look at more than one asset to gain a better understanding of stock prices.