Bootstrapping a Single-Tranche CDO

Abstract

The paper proposes a new methodology for bootstrapping a single-tranche CDO and estimating the term structure of expected loss. If for a CDS swap there is a clear established standard in the face of the ISDA CDS Standard Model that relies on a survival curve based on default intensity, for a CDO swap there is no equivalent counterpart available. It is not a priori clear what the survival curve in that case should look like. We propose both intensity like and copula based solutions sticking to efficiency and parsimony.

Keywords: swap, bootstrap, compensator, recovery, copula

JEL Classification: G13