An Analytical Approach for Systematic Risk Sensitivity of Structured Finance Products

Posted: 30 Oct 2013 Last revised: 15 Nov 2015

See all articles by Arndt Claussen

Arndt Claussen

Leibniz Universität Hannover

Sebastian Löhr

Leibniz Universität Hannover

Daniel Roesch

University of Regensburg

Date Written: 2014

Abstract

The global financial crisis has shown that many financial institutions dealing with credit derivatives were exposed to severe unexpected losses. This indicates that systematic influences are decisively underestimated particularly with regard to structured products like securitized tranches of collateralized debt obligations. Our analytical study addresses these systematic effects: We provide a simple model which allows a closed-form comparison of both bonds and tranches with respect to their systematic risk. We demonstrate that the exposure to systematic risk of tranches may be many times higher than the exposure of bonds, even if both products share the same rating grade, e.g., an ‘AAA’ rating, measured by either default probability or expected loss. Particularly in economic downturns, default rates of tranches may be multiples of those of bonds. Our results help understand high default rates of tranches during the financial crisis and show that classical ratings are insufficient metrics for measuring risks of structured products.

Keywords: Credit derivatives, CDO, Bond, Ratings, Systematic risk

JEL Classification: C16, C50, G21, G24

Suggested Citation

Claussen, Arndt and Löhr, Sebastian and Roesch, Daniel, An Analytical Approach for Systematic Risk Sensitivity of Structured Finance Products (2014). Review of Derivatives Research 17, 2014, 1-37, Available at SSRN: https://ssrn.com/abstract=2347347

Arndt Claussen

Leibniz Universität Hannover ( email )

Institut fur Rechnungslegung und WP
Koenigsworther Platz 1
Hannover, 30167
Germany

Sebastian Löhr

Leibniz Universität Hannover ( email )

Institut fur Rechnungslegung und WP
Koenigsworther Platz 1
Hannover, 30167
Germany

Daniel Roesch (Contact Author)

University of Regensburg ( email )

Chair of Statistics and Risk Management
Faculty of Business, Economics and BIS
Regensburg, 93040
Germany

HOME PAGE: http://www-risk.ur.de/

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