Low levels of risk are associated with low level returns, however, does anyone here know that why in some cases low levels of risk are associated with high level returns in CDO^2 transactions? Thank you.

Well - You are talking about different types of risk.A CDO2 transaction has higher leverage than a typical CDO as it is essentially leverage upon leverage. This itself is what allows the structure to have higher returns than a Managed/Static CDO or CDO of ABS of similar rating. The risk that you are referring to is, in my opinion, the fact that CDO2s [outside of operlapping names] essentially diversifies out any idiosyncratic risk but does leave an opening for systemic risk. So the high return/low risk is true only if you look at the fact that you ar 1) getting a higher return than similarly rated CDOs and 2) more diversified portfolio. However - you do no open up your self to increased risk via the leverage component and systemic spread movments. Can;t always have your cake and eat it to my friend...

Well - You are talking about different types of risk.A CDO2 transaction has higher leverage than a typical CDO as it is essentially leverage upon leverage. This itself is what allows the structure to have higher returns than a Managed/Static CDO or CDO of ABS of similar rating. The risk that you are referring to is, in my opinion, the fact that CDO2s [outside of operlapping names] essentially diversifies out any idiosyncratic risk but does leave an opening for systemic risk. So the high return/low risk is true only if you look at the fact that you ar 1) getting a higher return than similarly rated CDOs and 2) more diversified portfolio. However - you do no open up your self to increased risk via the leverage component and systemic spread movments. Can;t always have your cake and eat it to my friend...

No expert but it seems to me that whereas in CDOs you have conditional probabilities to work out, in CDO2 you have a pretty complex set of nested conditions to work out.

Actually pricing is not necessarity that different from a regular CDO - only have to apply certain weights per name when calculating and develop a method of net DV01 exposure to each name to hedge if necessary.