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Credit Risk Securitisation: Price Discovery for Synthetic CDOs

By Antje Schirm

Abstract

The paper provides empirical evidence on the pricing of synthetic credit risk securitisation. Securitisation is advantageous both for originating banks, who incur savings on bank capital costs and for investors, who acquire a stake in leveraged credit portfolio risk, an exposure type rarely accessible otherwise. Securitisation is cost-efficiently implemented by structured credit derivatives, issued securities are therefore referred to as synthetic collateralised debt obligations (CDOs). We perform arbitrage-free pricing of synthetic CDOs referring to investment grade European corporate debt, such that a comparison with observed transactions can be drawn. CDO payout rules are formalised, taking both direct risk transfer structures and synthetic transactions using SPVs for excess spread trapping into account. Underlying losses are captured by a reduced-form affine multi-factor model, exploiting the strong observed comovement of corporate spreads for systematic factor estimation. Estimation is performed by Kalman filter-based QML, applied to implied spread structures of recent European corporate bond issues to which originating banks are exposed. Valuation results are obtained for a variety of structural variants. A comparison with transactions accommodating our modelling approach with regard to payout rules and reference debt quality supports the hypothesis that investors have a strong preference for CDO investments: Observed note issuance spreads provide no adequate compensation for the leveraged portfolio risk exposure. Keywords: Credit risk securitisation, Multi-name credit derivatives, Corporate bonds, Reduced-form model, Affine defaultable term structure model, Kalman filter

Topics: Contingent-claim pricing
Year: 2004
OAI identifier: oai:CiteSeerX.psu:10.1.1.196.8809
Provided by: CiteSeerX
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