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Measuring the Credit Risk of Synthetic CDOs with CDS-Implied Ratings

ViewPoints, February 2009

21 Pages Posted: 4 Feb 2009 Last revised: 11 Feb 2009

David T. Hamilton

Moody's Analytics

Date Written: February 4, 2009

Abstract

In this paper, we demonstrate how CDS-implied ratings for corporate reference names, together with an analytic CDO ratings model, can be used to derive CDS-implied tranche ratings for corporate synthetic CDOs (CSOs). It is an experiment in which we change one key variable, the ratings of the portfolio of reference entities, while holding other data and model assumptions constant and measure how tranche ratings perform. We find that CDS-implied tranche ratings lead changes in Moody's ratings, more accurately rank order default losses by rating, and exhibit higher loss prediction accuracy ratios for the riskiest tranches.

Keywords: credit default swap, CDO, credit ratings

JEL Classification: G1, G2

Suggested Citation

Hamilton, David T., Measuring the Credit Risk of Synthetic CDOs with CDS-Implied Ratings (February 4, 2009). ViewPoints, February 2009. Available at SSRN: https://ssrn.com/abstract=1337629

David T. Hamilton (Contact Author)

Moody's Analytics ( email )

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