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An Empirical Analysis of the Pricing of Collateralized Debt Obligations

Francis Longstaff and Arvind Rajan

Journal of Finance, 2008, vol. 63, issue 2, 529-563

Abstract: We use the information in collateralized debt obligations (CDO) prices to study market expectations about how corporate defaults cluster. A three-factor portfolio credit model explains virtually all of the time-series and cross-sectional variation in an extensive data set of CDX index tranche prices. Tranches are priced as if losses of 0.4%, 6%, and 35% of the portfolio occur with expected frequencies of 1.2, 41.5, and 763 years, respectively. On average, 65% of the CDX spread is due to firm-specific default risk, 27% to clustered industry or sector default risk, and 8% to catastrophic or systemic default risk. Copyright 2008 by The American Finance Association.

Date: 2008
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Working Paper: An Empirical Analysis of the Pricing of Collateralized Debt Obligations (2006) Downloads
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