1 Department of Business Studies, Aarhus School of Business, Aarhus BSS, Aarhus University2 Finance Research Group, Aarhus School of Business, Aarhus BSS, Aarhus University
When the subprime crisis started emerging, collateralized products based on Credit Default Swap (CDS) exposures combined with security features seemed to be a more rational alternative to classic asset backed securities. Constant Proportion Collateralized Debt Obligations (CPDOs) are a mixture of Collateralized Debt Obligations (CDOs) and CPPIs with inverse mechanism. This new asset targets to meet the investors' demand for credit derivatives with security enhancements, but quantitative approaches for pricing except for simulation algorithms do not exist yet up to he author's knowledge. CPDOs became famous notably by Standard & Poor's rating model error which illustrated that closed-form analytical pricing is necessary in order to evaluate and understand complex derivatives. This article aims to shed a light on CPDOs specific structural enhancements and mechanisms. The author quantifies inherent risks and provides a dynamic closed-form pricing formula.
CPPI; Leverage; Shortfall; Barrier; Lévy process
Main Research Area:
Annual Conference on Risk Management and Corporate Governance, 2009