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schizoidman
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Joined: September 21st, 2005, 7:17 pm

Approximating CDO^2s

June 15th, 2010, 8:42 pm

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.
 
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frattyquant
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Joined: March 4th, 2010, 8:10 am

Approximating CDO^2s

June 22nd, 2010, 7:39 am

Wouldn't you have to model the correlation between the inner CDOs?
 
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dvl84
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Joined: July 6th, 2010, 1:01 pm

Approximating CDO^2s

July 7th, 2010, 6:28 pm

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.
 
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frattyquant
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Joined: March 4th, 2010, 8:10 am

Approximating CDO^2s

July 8th, 2010, 10:24 am

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.
 
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dvl84
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Approximating CDO^2s

July 8th, 2010, 10:44 am

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

Approximating CDO^2s

July 9th, 2010, 2:31 am

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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