Credit rating impact on CDO evaluation

Rösch, D; Scheule, H

Credit rating impact on CDO evaluation

Rösch, D Scheule, H

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Publication Type:: Journal Article
Citation:: Global Finance Journal, 2009, 19 (3), pp. 235 - 251
Issue Date:: 2009-01-01

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Field	Value	Language
dc.contributor.author	Rösch, D	en_US
dc.contributor.author	Scheule, H https://orcid.org/0000-0001-7283-5654	en_US
dc.date.issued	2009-01-01	en_US
dc.identifier.citation	Global Finance Journal, 2009, 19 (3), pp. 235 - 251	en_US
dc.identifier.issn	1044-0283	en_US
dc.identifier.uri	http://hdl.handle.net/10453/29816
dc.description.abstract	One of the most significant developments in international credit markets in recent years has been the trade in Collateralized Debt Obligations (CDO), which has enabled financial institutions to repackage the credit risk of an asset portfolio into tranches to be transferred to investors. The present paper evaluates the credit risk of such a portfolio and the related tranches by applying two prominent prototypes for credit ratings, namely the point-in-time and through-the-cycle approach. The central parameters default probability and correlation are forecast for multiple years and related forecasting errors are included. The article's main findings are that banks which transfer debt tranches but retain an equity part and apply a through-the-cycle rating approach may be exposed to higher insolvency risk. Firstly, the credit risk retained may be underestimated resulting in an inadequate capital allocation. Secondly, the credit risk transferred may be overestimated resulting in additional risk-based transfer costs. © 2008 Elsevier Inc. All rights reserved.	en_US
dc.relation.ispartof	Global Finance Journal	en_US
dc.relation.isbasedon	10.1016/j.gfj.2008.09.007	en_US
dc.subject.classification	Finance	en_US
dc.title	Credit rating impact on CDO evaluation	en_US
dc.type	Journal Article
utslib.citation.volume	3	en_US
utslib.citation.volume	19	en_US
utslib.for	1502 Banking, Finance and Investment	en_US
pubs.embargo.period	Not known	en_US
pubs.organisational-group	/University of Technology Sydney
pubs.organisational-group	/University of Technology Sydney/Faculty of Business
pubs.organisational-group	/University of Technology Sydney/Faculty of Business/Finance Discipline
pubs.organisational-group	/University of Technology Sydney/Strength - QFRC - Quantitative Finance Research Centre
utslib.copyright.status	closed_access
pubs.issue	3	en_US
pubs.publication-status	Published	en_US
pubs.volume	19	en_US

Abstract:

One of the most significant developments in international credit markets in recent years has been the trade in Collateralized Debt Obligations (CDO), which has enabled financial institutions to repackage the credit risk of an asset portfolio into tranches to be transferred to investors. The present paper evaluates the credit risk of such a portfolio and the related tranches by applying two prominent prototypes for credit ratings, namely the point-in-time and through-the-cycle approach. The central parameters default probability and correlation are forecast for multiple years and related forecasting errors are included. The article's main findings are that banks which transfer debt tranches but retain an equity part and apply a through-the-cycle rating approach may be exposed to higher insolvency risk. Firstly, the credit risk retained may be underestimated resulting in an inadequate capital allocation. Secondly, the credit risk transferred may be overestimated resulting in additional risk-based transfer costs. © 2008 Elsevier Inc. All rights reserved.

Please use this identifier to cite or link to this item:

http://hdl.handle.net/10453/29816