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The Risks in CDO-Squared Structures

Author

Listed:
  • Andrew Adams

    (University of Edinburgh Business School, U.K.)

  • Rajiv Bhatt

    (Deloitte Touche Tohmatsu India Pvt. Ltd., India)

  • James Clunie

    (Scottish Widows Investment Partnership, U.K.)

Abstract

The recent sub-prime debacle has brought ‘innovative’ structured credit products such as collateralized debt obligations under severe criticism. The complexity of some structured finance securities and difficulties in understanding their risks has been a common theme. This paper argues that CDO-squared structures can be so complex as to make risk assessment difficult. By modeling a simplified CDO-squared structure using Monte Carlo simulation, two of the risks unique to such structures are examined: default location risk and overlap risk. Failure to take account of these risks during a distressed credit environment will result in greater than anticipated losses among senior CDO-squared tranches.

Suggested Citation

  • Andrew Adams & Rajiv Bhatt & James Clunie, 2009. "The Risks in CDO-Squared Structures," Multinational Finance Journal, Multinational Finance Journal, vol. 13(1-2), pages 55-74, March-Jun.
  • Handle: RePEc:mfj:journl:v:13:y:2009:i:1-2:p:55-74
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    More about this item

    Keywords

    collateralized debt obligation; CDO-squared; default location risk; overlap risk; Monte Carlo simulation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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