Prague Economic Papers 2012, 21(1):30-49 | DOI: 10.18267/j.pep.409

Collateralized Debt Obligations' Valuation Using the One Factor Gaussian Copula Model

Petra Buzková, Petr Teplý
Faculty of Social Science, Institute of Economic Studies, Charles University in Prague (teply@fsv.cuni.cz; benesova_p@seznam.cz).

The aim of this paper is to shed light on Collateralized Debt Obligation (CDO) valuation based on data before and during the 2007-2009 global turmoil. We present the One Factor Gaussian Copula Model and examine five hypotheses regarding CDO sensitivity to entry parameters. For our modelling we used data of the CDX NA IG 5Y V3 index from 20 September 2007 until 27 February 2009 and we appropriately transform its quotes into CDO quotes. Based on the results we discovered four main deficiencies of the CDO market: i) an insufficient analysis of underlying assets by both investors and rating agencies; ii) investment decisions arise from the valuation model based on expected cash flows, they neglected other factors such as mark-tomarket losses; iii) mispriced correlation; and finally iv) obligation of the mark-to-market valuation. Based on the mentioned recommendations we conclude that the CDO market has a chance to be regenerated but in smaller volumes compared to the pre-crisis period. However, it would then be more conscious, driven by smarter motives rather than by pure arbitrage and profit incentives.

Keywords: Collateralized Debt Obligations, Copula Function, valuation, securitization, One Factor Gaussian Copula Model
JEL classification: C63, G01, G15, G17

Published: January 1, 2012  Show citation

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Buzková, P., & Teplý, P. (2012). Collateralized Debt Obligations' Valuation Using the One Factor Gaussian Copula Model. Prague Economic Papers, 21(1), 30-49. doi: 10.18267/j.pep.409
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