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

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  • Petra Buzková
  • Petr Teplý

Abstract

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.

Suggested Citation

  • Petra Buzková & Petr Teplý, 2012. "Collateralized Debt Obligations' Valuation Using the One Factor Gaussian Copula Model," Prague Economic Papers, Prague University of Economics and Business, vol. 2012(1), pages 30-49.
    • Handle: RePEc:prg:jnlpep:v:2012:y:2012:i:1:id:409:p:30-49
    DOI: 10.18267/j.pep.409
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    References listed on IDEAS

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    1. Jeffery D Amato & Jacob Gyntelberg, 2005. "CDS index tranches and the pricing of credit risk correlations," BIS Quarterly Review, Bank for International Settlements, March.
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    Cited by:

    1. Janda, Karel & Zetek, Pavel, 2013. "Macroeconomic factors influencing interest rates of microfinance institutions in Latin America," MPRA Paper 49973, University Library of Munich, Germany.
    2. Karel JANDA & Pavel ZETEK, 2014. "Macroeconomic factors influencing interest rates of microfinance institutions in the Latin America and the Caribbean," Agricultural Economics, Czech Academy of Agricultural Sciences, vol. 60(4), pages 159-173.
    3. Štěpán Chrz & Karel Janda & Ladislav Krištoufek, 2014. "Modelování provázanosti trhů potravin, biopaliv a fosilních paliv [Modeling Interconnections within Food, Biofuel, and Fossil Fuel Markets]," Politická ekonomie, Prague University of Economics and Business, vol. 2014(1), pages 117-140.

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    More about this item

    Keywords

    Collateralized Debt Obligations; Copula Function; valuation; securitization; One Factor Gaussian Copula Model;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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