Stressing Rating Criteria Allowing for Default Clustering: the CPDO case

37 Pages Posted: 15 Jan 2008 Last revised: 9 Sep 2009

See all articles by Roberto Torresetti

Roberto Torresetti

Università degli Studi di Milano; Intesa SanPaolo

Andrea Pallavicini

Intesa Sanpaolo

Date Written: October 5, 2007

Abstract

After a brief review of the literature on rating arbitrage for corporate and structured finance, we introduce the standard criteria adopted by rating agencies to assess riskiness of Constant Proportion Debt Obligations (CPDO). Then, we propose a new rating model in order to incorporate a more realistic loss distribution showing a multi-modal shape, which, in turn, is linked to default possibilities for clusters (possibly sectors) of names of the economy. In this framework, we show that the riskiness of CPDOs is substantially increased leading to a decrease of their rating, and in particular, we found that the expected payout of the gap-risk option, embedded in CPDOs, is greatly enhanced.

Keywords: CPDO Rating, Rating Arbitrage, Structured Finance, Loss Distribution, Loss Dynamics, Cluster Default Dynamics, Gap Risk

JEL Classification: G13

Suggested Citation

Torresetti, Roberto and Pallavicini, Andrea, Stressing Rating Criteria Allowing for Default Clustering: the CPDO case (October 5, 2007). Available at SSRN: https://ssrn.com/abstract=1077762 or http://dx.doi.org/10.2139/ssrn.1077762

Roberto Torresetti (Contact Author)

Università degli Studi di Milano ( email )

via Festa del Perdono, 7
Milano
Italy

Intesa SanPaolo ( email )

Milan
Italy

Andrea Pallavicini

Intesa Sanpaolo ( email )

Largo Mattioli 3
Milan, MI 20121
Italy

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