CDO Deltas

Keanu · October 5th, 2005, 3:36 pm

Hi,suppose we have synthetic CDO consisting of 100 CDS with 1million notional each.If calculate the hedge ratio for a particular single name w.r.t. to all tranches, (Bump CDS-Spreads by 1bps an the reprice) i.e. H_i = Delta_CDO_Tranche_i /Delta_CDS (for 0-3,3-6,6-9, ....).Shouldn't the H_i add up to one, because if you hold every CDS you haveperfect hedge.They don't seem to do that in the market standard one factor model (roughly 1.1).Any suggestions ?Thanks,Keanu

Ri · October 5th, 2005, 8:18 pm

good question. in fact holding all the tranches is different from holding the underlying portfolio.You can see this by looking at what happens in terms of carry if 5 names default (exactly wiping out your equity tranche). Let's say all the names are at 50bps. On sum of tranches, you lose the equity premium ie 500bps on the equity tranche notionalOn underlying portfolio, you lose 50bps on the equity tranche notional=> so sum of tranches != underlying portfolio as soon as you start paying coupons on the tranchescheers

Keanu · October 6th, 2005, 2:43 pm

good point.If I calculate the hedge rations only w.r.t to Credit Legs(asumming premium is paid upfront), they sum up 0.988.cheers

noyghou · October 7th, 2005, 4:47 am

I don really get it. why 5 names default translate into 500bps on equity tranch notional? I mean we dont even know the equity premium, and premiums on all other tranches, do we? can somebody explain this in more detail? thanx in advance.

surrey · October 28th, 2005, 2:13 pm

how do you mark the skew in the Cdo market or any market where you use copula.Was wondering if anybody would know anything regarding it. I want to know wht do you mean by the skew in the credit market and how do price the products after having the knowledge of the skew.I could call you up if tht would help. I really appreciate your help. Many thanks