An Empirical Analysis of the Pricing of Collateralized Debt Obligations
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Date: 04-19-2007
Start Time:
5:30pm
End Time: 7:00pm
Speaker: Francis A. Longstaff, UCLA
Location: Dahesh Auditorium, 580 Madison Ave (Madison & 56th street)
ABSTRACT
We use the information in collateralized debt obligation (CDO) prices to study market expectations about how corporate defaults cluster or are correlated across firms. We find that a three factor portfolio credit model allowing for firm-specific ,industry, and economywide default events explains virtually all of the time series and cross-sectional variation in an extensive data set of CDX index trancheprices. These tranches are priced as if losses of 0.4, 6, and 35 percent of the portfolio occur with expected frequencies under the risk-neutral measure of 1.2, 41.5, and 763 years, respectively. On average, 65 percent of the CDX spread is due to firm-specific default risk, 27 percent to clustered industry or sector default risk, and 8 percent to catastrophic or systemic default risk. Recently, however, firm-specific default risk has begun to play a larger role.
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