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An Empirical Analysis of the Pricing of Collateralized Debt Obligations
Author(s) -
LONGSTAFF FRANCIS A.,
RAJAN ARVIND
Publication year - 2008
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2008.01330.x
Subject(s) - collateralized debt obligation , tranche , itraxx , credit derivative , portfolio , default , synthetic cdo , debt , business , financial economics , credit risk , credit default swap index , systemic risk , economics , actuarial science , credit valuation adjustment , finance , financial crisis , collateral , credit reference , macroeconomics
We use the information in collateralized debt obligations (CDO) prices to study market expectations about how corporate defaults cluster. A three‐factor portfolio credit model explains virtually all of the time‐series and cross‐sectional variation in an extensive data set of CDX index tranche prices. Tranches are priced as if losses of 0.4%, 6%, and 35% of the portfolio occur with expected frequencies of 1.2, 41.5, and 763 years, respectively. On average, 65% of the CDX spread is due to firm‐specific default risk, 27% to clustered industry or sector default risk, and 8% to catastrophic or systemic default risk.