The Impossible Trio in CDO Modeling

Emmanuel Schertzer, Yadong Li and Umer Khan

Papers from arXiv.org

Abstract: We show that stochastic recovery always leads to counter-intuitive behaviors in the risk measures of a CDO tranche - namely, continuity on default and positive credit spread risk cannot be ensured simultaneously. We then propose a simple recovery variance regularization method to control the magnitude of negative credit spread risk while preserving the continuity on default.

Date: 2010-12
New Economics Papers: this item is included in nep-ban and nep-rmg
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