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Conference Paper: Model specification, data history, and CDO (mis)pricing

TitleModel specification, data history, and CDO (mis)pricing
Other TitlesA little knowledge is a dangerous thing: model specification, data history, and CDO (mis)pricing
Authors
KeywordsCDO
Model specification
Data history
Default correlation
Frailty
Issue Date2009
Citation
The International Symposium on Risk Management and Derivatives (ISRMD). Xiamen, China, 4-6 July 2009. How to Cite?
AbstractThe revaluation of collateralized debt obligations (CDOs) plays a significant role in the ongoing 2007-2009 credit crisis. Starting in August 2007, a large amount of initially AAA rated CDO securities are substantially downgraded, some directly to junk grade. This paper explores two structural sources of CDO mispricing: modeling difficulty and data limitation. Simulating the frailty correlated default model of Duffie, Eckner, Horel, and Saita (2008), we show that CDO mis-pricing can be partly attributed to model misspecifications, as well as limited availability of historical data on CDO collateral assets. This simulation result is consistent with empirical evidence on historical performance of a sample of 279 CDOs. The frailty model estimated with adequate historical data would have reduced the amount of AAA rated CDO securities by 12% on average. The frailty model has predictive power for the subsequent downgrading of AAA rated CDO tranches. Our study addresses practical issues on financial innovations and provides guidance for corresponding risk management.
DescriptionSession 6A - Investor Risk Behavior: no. 3
Persistent Identifierhttp://hdl.handle.net/10722/114921

 

DC FieldValueLanguage
dc.contributor.authorLuo, Den_HK
dc.contributor.authorTang, DYen_HK
dc.contributor.authorWang, SQen_HK
dc.date.accessioned2010-09-26T05:22:02Z-
dc.date.available2010-09-26T05:22:02Z-
dc.date.issued2009en_HK
dc.identifier.citationThe International Symposium on Risk Management and Derivatives (ISRMD). Xiamen, China, 4-6 July 2009.-
dc.identifier.urihttp://hdl.handle.net/10722/114921-
dc.descriptionSession 6A - Investor Risk Behavior: no. 3-
dc.description.abstractThe revaluation of collateralized debt obligations (CDOs) plays a significant role in the ongoing 2007-2009 credit crisis. Starting in August 2007, a large amount of initially AAA rated CDO securities are substantially downgraded, some directly to junk grade. This paper explores two structural sources of CDO mispricing: modeling difficulty and data limitation. Simulating the frailty correlated default model of Duffie, Eckner, Horel, and Saita (2008), we show that CDO mis-pricing can be partly attributed to model misspecifications, as well as limited availability of historical data on CDO collateral assets. This simulation result is consistent with empirical evidence on historical performance of a sample of 279 CDOs. The frailty model estimated with adequate historical data would have reduced the amount of AAA rated CDO securities by 12% on average. The frailty model has predictive power for the subsequent downgrading of AAA rated CDO tranches. Our study addresses practical issues on financial innovations and provides guidance for corresponding risk management.-
dc.languageengen_HK
dc.relation.ispartofInternational Symposium on Risk Management and Derivativesen_HK
dc.rightsCreative Commons: Attribution 3.0 Hong Kong License-
dc.subjectCDO-
dc.subjectModel specification-
dc.subjectData history-
dc.subjectDefault correlation-
dc.subjectFrailty-
dc.titleModel specification, data history, and CDO (mis)pricingen_HK
dc.title.alternativeA little knowledge is a dangerous thing: model specification, data history, and CDO (mis)pricing-
dc.typeConference_Paperen_HK
dc.identifier.emailLuo, D: luodan35@hku.hken_HK
dc.identifier.emailTang, DY: yjtang@hku.hken_HK
dc.identifier.emailWang, SQ: sarawang@hku.hken_HK
dc.identifier.authorityTang, DY=rp01096en_HK
dc.description.naturepostprint-
dc.identifier.hkuros166717en_HK
dc.description.otherThe International Symposium on Risk Management and Derivatives (ISRMD). Xiamen, China, 4-6 July 2009.-

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