PT - JOURNAL ARTICLE AU - Tania Garcia AU - Arthur Maghakian AU - Sanjay Sharma TI - Implications of Stochastic Recovery Rates in Evaluating CDO Tranches AID - 10.3905/jfi.2004.461452 DP - 2004 Dec 31 TA - The Journal of Fixed Income PG - 64--71 VI - 14 IP - 3 4099 - https://pm-research.com/content/14/3/64.short 4100 - https://pm-research.com/content/14/3/64.full AB - The binomial expansion technique originally proposed by Moody's has been widely adopted as the standard technique for assessing the risk of CBO/CLO tranches. The key assumption underlying it is the non-variability of recovery rates. A comparison with the results produced by Monte Carlo simulation assuming stochastic recovery rates indicates rating differentials of up to five rating notches in ratings of CBO/CLO tranches that are attributable to the recovery rate assumption. Some adjustments to constant recovery rates would make the ratings indicated by the BET more consistent with the results of Monte Carlo simulation.