Pricing structured products with economic covariates

Yong Seok Choi, Hitesh Doshi, Kris Jacobs and Stuart M. Turnbull

Journal of Financial Economics, 2020, vol. 135, issue 3, 754-773

Abstract: We introduce a top-down no-arbitrage model for pricing structured products. Losses are described by Cox processes whose intensities depend on economic variables. The model provides economic insight into the impact of structured products on financial institutions’ risk exposure and systemic risk. We estimate the model using CDO data and find that spreads decrease with higher interest rates and increase with volatility and leverage. Volatility is the primary determinant of variation in tranche spreads. Leverage and interest rates are more closely associated with rare credit events. Model-implied risk premiums and the probabilities of tranche losses increase substantially during the financial crisis.

Keywords: Structured product; Collateralized debt obligation; Tranche pricing; Economic determinants; Risk premiums (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:135:y:2020:i:3:p:754-773

DOI: 10.1016/j.jfineco.2019.08.002

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