Managing Synthetic CDO Tranches using Base Correlations
Managing Synthetic CDO Tranches using Base Correlations Managing Synthetic CDO Tranches using Base Correlations
Stress Test Example for CDX.NA.IG S8 July 25-26, 2007 Market observables (relative movements) CDX spread: +23% Upfront fee: +15% Implied movement of base correlation 0-3% tranche: +17% Recall a decrease in equity price can be caused by Explained portion: Increase CDX spread (increase in default probabilities) Unexplained portion: Decrease in correlation (“sporadic” defaults will increase) 18
Apply stress test Assume stress applies to a “calm” market environment Explicit base correlation shift Base correlation stress increases price Positions Tranche notional ($M) Upfront price ($M) DV01 ($000) Index ($000) Base correl ($000) Market spreads ($000) Sell 0-3% 3 0.73 -29 -217 64 -141 Sell 3-7% 4 0.00 -10 -82 -2 -78 Index 50 0.00 -22 -183 0 -183 Implicit base correlation shift Positions Tranche notional ($M) Upfront price ($M) DV01 ($000) Index ($000) Base correl $000) Market spreads ($000) Sell 0-3% 3 0.73 -29 -217 -108 -349 Sell 3-7% 4 0.00 -10 -82 -63 -188 Index 50 0.00 -22 -183 0 -183 19
- 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 14 and 15: Stress tests Base correlations c
- Page 16 and 17: Subprime crisis has spread to … L
- 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
Stress Test Example for CDX.NA.IG S8<br />
July 25-26, 2007<br />
Market observables (relative movements)<br />
CDX spread: +23%<br />
Upfront fee: +15%<br />
Implied movement of base correlation<br />
0-3% tranche: +17%<br />
<br />
Recall a decrease in equity price can be caused by<br />
Explained portion: Increase CDX spread (increase in default probabilities)<br />
Unexplained portion: Decrease in correlation (“sporadic” defaults will increase)<br />
18
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