Synthetic CDO Equity

Abstract

This article clarifies and contests the common market belief that synthetic CDO equity is long correlation risk, i.e. as correlation increases equity spreads decline. In fact, the impact of correlation on CDO equity spreads is indeterminate apriori and model specific. We argue that, for realistic models, CDO equity will be short correlation risk, contrary to common belief.

TOPICS: CLOs, CDOs, and other structured credit, credit risk management, statistical methods, financial crises and financial market history