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Conference Paper: A little knowledge is a dangerous thing: model specification, data history, and CDO (mis)pricing

TitleA 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 2009 China International Conference in Finance (CICF), Guangzhou, China, 7-10 July 2009. How to Cite?
2009中国金融国际年会, 中国, 广州, 2009年7月7日至10日. 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 (2009), 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 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.
Persistent Identifierhttp://hdl.handle.net/10722/114960

 

DC FieldValueLanguage
dc.contributor.authorLuo, Den_HK
dc.contributor.authorTang, DYen_HK
dc.contributor.authorWang, SQen_HK
dc.date.accessioned2010-09-26T05:23:47Z-
dc.date.available2010-09-26T05:23:47Z-
dc.date.issued2009en_HK
dc.identifier.citationThe 2009 China International Conference in Finance (CICF), Guangzhou, China, 7-10 July 2009.-
dc.identifier.citation2009中国金融国际年会, 中国, 广州, 2009年7月7日至10日.zh_HK
dc.identifier.urihttp://hdl.handle.net/10722/114960-
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 (2009), 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 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.ispartofChina International Conference in Financeen_HK
dc.relation.ispartof中国金融国际年会zh_HK
dc.subjectCDO-
dc.subjectModel specification-
dc.subjectData history-
dc.subjectDefault correlation-
dc.subjectFrailty-
dc.titleA little knowledge is a dangerous thing: model specification, data history, and CDO (mis)pricingen_HK
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.hkuros164553en_HK
dc.description.otherThe 2009 China International Conference in Finance (CICF), Guangzhou, China, 7-10 July 2009.-
dc.description.other2009中国金融国际年会, 中国, 广州, 2009年7月7日至10日.-

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