Managing Synthetic CDO Tranches using Base Correlations

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Stress tests <strong>Base</strong> correlations can be stressed directly or indirectly Indirect stresses involve market observables: Upfront fee of equity and junior tranches Tranche fair spreads Stresses should propagate up the capital structure Each stress shift involving market quotes is translated into a base correlation shift Example: 0-3% Upfront fee increases bootstrap: calculate ρ 3 ’ 3-7% Tranche fair spread increases bootstrap: calculate ρ 7 ’(use ρ 3 ’) 7-10% No stress is applied bootstrap: ρ 10 ’(use ρ 7 ’) 14
Recent market volatility: US subprime crisis In late February, credit problems emerged in US subprime mortgages 6000 ABX.HE.07-1 BBB spread BBB Spread 5000 4000 3000 Price deterioration: June 1: 75% July 31: 40% 2000 1000 0 Jan07 Mar07 May07 Jul07 Sep07 15
Page 2 and 3: Managing synthetic CDO tranches usi
Page 4 and 5: Synthetic CDO mechanics losses Pro
Page 6 and 7: Protection buyer can hedge by selli
Page 8 and 9: Agenda Synthetic CDO mechanics Ba
Page 10 and 11: Gaussian Copula Model (con’t) S
Page 12 and 13: Base correlation framework Each tr
Page 16 and 17: Subprime crisis has spread to … L
Page 18 and 19: Stress Test Example for CDX.NA.IG S
Page 20 and 21: So which stress test makes sense I
Page 22 and 23: Agenda Synthetic CDO mechanics Ba
Page 24 and 25: Mapping base correlations between b
Page 26 and 27: Base correlation mapping methods Fi
Page 28 and 29: Method 4: Expected Tranche Loss Pro
Page 30 and 31: Comparison of mappings for iTraxx S
Page 32 and 33: Heterogeneous portfolios Can we fin
Page 34 and 35: Consider linear interpolation iTrax
Page 36: Summary Base correlation are usef

Managing Synthetic CDO Tranches using Base Correlations

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