European Securitization: A Garch Model of CDO, MBS and Pfandbrief Spreads
Journal of Structured Finance, Vol. 12, No. 1, pp. 55-80
J.W. Goethe Universitaet Frankfurt am Main Finance Working Paper No. 121
43 Pages Posted: 13 Apr 2005
Asset-backed securitization (ABS) is a highly flexible yet complex refinancing technique that involves the issuance of contingent claims with varying seniority on the cash flow performance of a designated pool of asset exposures. Efficient risk management of ABS obligations requires both investors and issuers to thoroughly understand the inherent spread dynamics in this growing segment of fixed income markets. We model the heteroskedasticity of weekly secondary market spreads of European CDO, MBS and Pfandbrief transactions in a multi-factor GARCH process for valuation and forecasting purposes. We find that expected spread changes follow a positive trend with asymmetric mean reversion depending on the direction of past spread changes. Model estimates indicate a statistically and economically stronger contribution by negative first moments of past spreads on mean spread changes. Most of the conditional spread volatility is informed by negative past innovations, which constitute most of the economic significance of a positive general GARCH effect. These spread dynamics over our sample period imply that negative shocks associated with unexpected spread declines seem to induce higher spread volatility when persistent (or increasing) spread levels testify to negative investor sentiment.
Keywords: Securitisation, MBS, CDO, CLO, CBO, ABS, Pfandbrief, GARCH model, structured finance, spread dynamics
JEL Classification: C12, C32, C53, G12, G21
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