A trick of the credit tail

Leveraged super-senior (LSS) trades represent a mechanism for packaging senior credit risk. Many LSS structures have been issued to date and yet there seems to be no formal pricing approach. In this article, Jon Gregory discusses the valuation of LSS protection in a model-independent framework. He argues that the 'equivalence' approach to pricing that seems widely used is not appropriate

The structured credit market has grown rapidly in recent years with the use of synthetic collateralised debt obligations (CDOs), which allow issuers to sell a particular tranche of a portfolio hedged with more simple instruments such as single-name credit default swaps. One problem in the early development of the CDO market was the fact that correlation was a key input to the pricing but was a rather opaque quantity. The development of the index tranche market in 2004 provided a solution to this