An Empirical Analysis of the Pricing of Collateralized Debt Obligations
<-- Return to the list
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 tranche prices. 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.
BIO
Francis A. Longstaff is Professor of Finance at the UCLA Anderson School of Management.
From 1995 to 1998, Professor Longstaff was head of
Fixed Income Derivative Research at Salomon Brothers Inc. in New York.
Professor Longstaff has also worked in the research department of the
Chicago Board of Trade and for Deloitte and Touche as a management
consultant. He has authored many pioneering research paper on interest rate modeling and derivative pricing, on topics such as the valuation of American options by simulation, the
valuation of interest rate derivatives in string models of the term structure, the risk/return relationship for hedge funds investing under margin constraints.