Optimal Tranching in CDO-Transactions

Abstract

This paper empirically investigates the tranching of European securitizations of corporate loans and bonds. Loans or bonds are pooled together in a portfolio which then is sliced into a First Loss Position and rated bond tranches. The originator tranches so as to minimize the sum of the credit spreads paid on the rated tranches. We find that the number of rated tranches is inversely related to the asset pool quality. The price for transferring a unit of expected default risk is inversely related to the number of subordinated tranches, it is higher for the lowest rated tranche, it is very high for the AAA-tranches in true sale-transactions. The price increases with the credit support of a tranche, but declines when the default probability of the portfolio increases.

Keywords: Securitization, information asymmetries, tranching of asset portfolios, risk premia

JEL Classification: G12, G14, G24