Why did CPDOs fail? An analysis focused on credit spread modeling

Silvana Musti () and Viviana Fanelli

Quaderni DSEMS from Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia

Abstract: In this paper we propose a model to evaluate the performance of a Constant Proportion Debt Obligation (CPDO) and assess its rating. We model credit spread evolution in a HJM framework and default events for CPDO are generated by using a reduced form approach. Implementing a numerical algorithm that simulates the strategy of a CPDO, we obtain a rating for CPDO by using Monte Carlo simulations. We find a rating inferior to the one assigned by rating agencies. Using our model for credit spread dynamics, the revealed default probability for CPDO could have been predicted.

Date: 2010-06
New Economics Papers: this item is included in nep-cmp and nep-fmk
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