Overview of the CDO market

By Eileen Murphy

INTRODUCTION

Collateralised debt obligations (CDOs) represent one of the fastestgrowing segments of the structured finance world and are sometimes lumped together with asset backed securities (ABSs). However, there are several fundamental differences between CDOs and ABSs. CDOs allow for the pooling and retranching of credit risk with pools that are almost always much lumpier than their ABS cousins and with structures that can be tailored to a particular asset class, pool or manager. The flexibility of the CDO product has important repercussions in terms of understanding the product and in determining which analytical methods are best used to evaluate them. Accordingly, analytical approaches must move away from an actuarial method to one that recognises the heterogeneous nature of the pools.

Any evaluation of CDOs must also take into account that CDOs represent the far end of the continuum that begins with single-name default trades, continues with baskets of possible defaults and finally goes to the extreme of those rare CDOs that have thousands of underlying credits. Finally, CDOs, unlike ABS transactions, usually have an asset manager actively buying and selling assets in the

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