A Benchmark for Collateralized Loan Obligations
59 Pages Posted: 9 Jan 2021
Date Written: November 18, 2020
We build a benchmark for AAA-rated tranches of Collateralized Loan Obligations (CLOs) using Business Development Companies (BDCs), which hold a diversified portfolio of loans as CLOs do. However, BDCs are publicly listed, and their share price, equity volatility and borrowing cost are observable. Furthermore, BDCs' debt is not rated as AAA. Applying a structural model to BDCs, we extract market-implied correlation in their loan portfolio, compare spreads on CLO tranches and BDC-implied benchmark, and find that observed large credit spreads on CLO senior tranches after the financial crisis are a fair reflection of the systematic risk of correlated loan defaults.
Keywords: Corporate credit spreads, Structural credit risk models, the Merton model, Fixed income asset pricing
JEL Classification: G12, G13
Suggested Citation: Suggested Citation