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On the Relative Pricing of Long‐Maturity Index Options and Collateralized Debt Obligations
Author(s) -
COLLINDUFRESNE PIERRE,
GOLDSTEIN ROBERT S.,
YANG FAN
Publication year - 2012
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.1540-6261.2012.01779.x
Subject(s) - collateralized debt obligation , tranche , index (typography) , maturity (psychological) , jump , debt , credit derivative , financial economics , economics , order (exchange) , market sentiment , business , credit risk , actuarial science , collateral , finance , computer science , psychology , developmental psychology , physics , quantum mechanics , world wide web
We investigate a structural model of market and firm‐level dynamics in order to jointly price long‐dated S&P 500 index options and CDO tranches of corporate debt. We identify market dynamics from index option prices and idiosyncratic dynamics from the term structure of credit spreads. We find that all tranches can be well priced out‐of‐sample before the crisis. During the crisis, however, our model can capture senior tranche prices only if we allow for the possibility of a catastrophic jump. Thus, senior tranches are nonredundant assets that provide a unique window into the pricing of catastrophic risk.