A Benchmark for Collateralized Loan Obligations

71 Pages Posted: 9 Jan 2021 Last revised: 11 Jan 2022

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Ruicong Li

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Yoshio Nozawa

University of Toronto

Date Written: January 11, 2022

Abstract

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

Elkamhi, Redouane and Li, Ruicong and Nozawa, Yoshio, A Benchmark for Collateralized Loan Obligations (January 11, 2022). HKUST Business School Research Paper No. 2020-012, Available at SSRN: https://ssrn.com/abstract=3732614 or http://dx.doi.org/10.2139/ssrn.3732614

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Ruicong Li

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay
Kowloon, 999999
Hong Kong

Yoshio Nozawa (Contact Author)

University of Toronto ( email )

105 St George St
Toronto, ON M5S3E6
Canada
3013125569 (Phone)

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