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
Date Written: February 4, 2009
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
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