Implied Expected Tranched Loss Surface from CDO Data

13 Pages Posted: 28 Sep 2006

See all articles by Roberto Torresetti

Roberto Torresetti

Banco Popolare

Damiano Brigo

Imperial College London - Department of Mathematics

Andrea Pallavicini

Banca IMI; Imperial College London - Department of Mathematics

Date Written: May 3, 2007

Abstract

We explain how the payoffs of credit indices and tranches are valued in terms of expected tranched losses (ETL). ETL are natural quantities to imply from market data. No-arbitrage constraints on ETL's as attachment points and maturities change are introduced briefy. As an alternative to the temporally inconsistent notion of implied correlation we consider the ETL surface, built directly from market quotes given minimal interpolation assumptions. We check that the kind of interpolation does not interfere excessively. Instruments bid/asks enter our analysis, contrary to Walker's (2006) earlier work on the ETL implied surface. By doing so we find less and very few violations of the no-arbitrage conditions. The ETL implied surface can be used to value tranches with nonstandard attachments and maturities as an alternative to implied correlation.

Keywords: expected tranche loss, loss surface, implied correlation, CDO, tranches, interpolation

JEL Classification: G13

Suggested Citation

Torresetti, Roberto and Brigo, Damiano and Pallavicini, Andrea, Implied Expected Tranched Loss Surface from CDO Data (May 3, 2007). Available at SSRN: https://ssrn.com/abstract=933291 or http://dx.doi.org/10.2139/ssrn.933291

Roberto Torresetti (Contact Author)

Banco Popolare ( email )

Milan
Italy

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Andrea Pallavicini

Banca IMI ( email )

Largo Mattioli 3
Milan, MI 20121
Italy
+39 02 7261 (Phone)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

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