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A bottom-up, reduced form credit risk model approach for the determination of collateralised loan obligation capital

Author

Listed:
  • Jarrow, Robert

    (Ronald P. and Susan E. Lynch Professor of Investment Management, Cornell University, USA)

  • Van Deventer, Donald R.

    (Managing Director, SAS Institute Inc., USA)

Abstract

This paper uses a bottom-up, reduced form credit risk model with hazard rate estimated default probabilities to compute various collateralised loan obligation (CLO) tranches' loss probabilities and capital factors. It is shown that with respect to the loss probabilities, credit rated CLO tranches are less risky than comparably rated corporate bonds. In addition, a similar argument can be made that corporate debt loss rates will be on average larger than equally rated CLO tranche loss rates. And, it is shown that the National Association of Insurance Commissioners (NAIC) capital factors are typically larger than value-at-risk based capital factors. The policy implication is that NAIC capital factors distort investment incentives by requiring too much capital for CLOs relative to equally rated corporate debt.

Suggested Citation

  • Jarrow, Robert & Van Deventer, Donald R., 2023. "A bottom-up, reduced form credit risk model approach for the determination of collateralised loan obligation capital," Journal of Risk Management in Financial Institutions, Henry Stewart Publications, vol. 16(3), pages 237-255, June.
    • Handle: RePEc:aza:rmfi00:y:2023:v:16:i:3:p:237-255
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    Cited by:

    1. Chuang-Chang Chang & Hsiao-Wei Ho & Henry Hongren Huang & Yildiray Yildirim, 2024. "A reduced-form model for lease contract valuation with embedded options," Review of Quantitative Finance and Accounting, Springer, vol. 62(2), pages 841-864, February.

    More about this item

    Keywords

    collateralised loan obligations; NAIC capital factors; loss probabilities; credit risk; value-at-risk;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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