Loan securitisation: default term structure and asset pricing based on loss prioritisation

Andreas Jobst ()

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Ambivalence in the regulatory definition of capital adequacy for credit risk has recently stirred the financial services industry to collateral loan obligations (CLOs) as an important balance sheet management tool. CLOs represent a specialised form of Asset-Backed Securitisation (ABS), with investors acquiring a structured claim on the interest proceeds generated from a portfolio of bank loans in the form of tranches with different seniority. By way of modelling Merton-type risk-neutral asset returns of contingent claims on a multi-asset portfolio of corporate loans in a CLO transaction, we analyse the optimal design of loan securitisation from the perspective of credit risk in potential collateral default. We propose a pricing model that draws on a careful simulation of expected loan loss based on parametric bootstrapping through extreme value theory (EVT). The analysis illustrates the dichotomous effect of loss cascading, as the most junior tranche of CLO transactions exhibits a distinctly different default tolerance compared to the remaining tranches. By solving the puzzling question of properly pricing the risk premium for expected credit loss, we explain the rationale of first loss retention as credit risk cover on the basis of our simulation results for pricing purposes under the impact of asymmetric information.

Keywords: Loan securitisation; CLO; Structured finance (search for similar items in EconPapers)
JEL-codes: C15 C22 D82 F34 G13 G18 G20 (search for similar items in EconPapers)
Pages: 94 pages
Date: 2002-08-01
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http://eprints.lse.ac.uk/24941/ Open access version. (application/pdf)

Related works:
Working Paper: Loan Securitisation: Default Term Structure and Asset Pricing Based on Loss Prioritisation (2002)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:24941

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