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schizoidman
Topic Author
Posts: 123
Joined: September 21st, 2005, 7:17 pm

Approximating CDO^2s

Can I approximate a CDO^2 by calculating the ATM spreads of the inner tranches, and then pricing the outer/master CDO as a single tranche with each inner tranche represented by a flat spread curve? The structure is standard and short dated. A quick-and-dirty approximation should do the job.

frattyquant
Posts: 362
Joined: March 4th, 2010, 8:10 am

Approximating CDO^2s

Wouldn't you have to model the correlation between the inner CDOs?

dvl84
Posts: 14
Joined: July 6th, 2010, 1:01 pm

Approximating CDO^2s

Most synth CDO^2 that were sold were actually 'CDO^2 with cross subordination' - meaning that if your tranche was about to get 'hit' in any of the inner, any further losses in this inner would be absorbed by subordination in any other inner. This effectively makes it a 'normal' tranche. If you want to do some quick and dirty calc, I'd do it like that.

frattyquant
Posts: 362
Joined: March 4th, 2010, 8:10 am

Approximating CDO^2s

QuoteOriginally posted by: dvl84Most synth CDO^2 that were sold were actually 'CDO^2 with cross subordination' - meaning that if your tranche was about to get 'hit' in any of the inner, any further losses in this inner would be absorbed by subordination in any other inner. This effectively makes it a 'normal' tranche. If you want to do some quick and dirty calc, I'd do it like that.Would you mind giving an example of what you're talking about? I don't get what you mean by normal tranche.

dvl84
Posts: 14
Joined: July 6th, 2010, 1:01 pm

Approximating CDO^2s

sure, let's say this.. say you got 5 inner CDO's - those all got a tranche of 3-5% and using those 5 tranches a new CDO it 'built' where you got a 12-15% tranche. Instead of modelling all these CDO's where do you go wrong if you would model a single portfolio (consisting of all the 5 inner portfolio's) and adjust the tranche size. As I said, in case you got x-sub you get slightly off if there is almost none subordination left in any of the inner CDO's but if you are looking for a quick and dirty way - I'd do it like this.

frattyquant
Posts: 362
Joined: March 4th, 2010, 8:10 am

Approximating CDO^2s

QuoteOriginally posted by: dvl84sure, let's say this.. say you got 5 inner CDO's - those all got a tranche of 3-5% and using those 5 tranches a new CDO it 'built' where you got a 12-15% tranche. Instead of modelling all these CDO's where do you go wrong if you would model a single portfolio (consisting of all the 5 inner portfolio's) and adjust the tranche size. As I said, in case you got x-sub you get slightly off if there is almost none subordination left in any of the inner CDO's but if you are looking for a quick and dirty way - I'd do it like this.Oh that makes sense. Thats a pretty easy way to get a back of the envelope calculation. Thanks.

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