Demystifying the practice of synthetic CDO valuation

Nosheen Khan, vice president, structured credit valuations at Markit, examines the base correlation mapping methods for implying bespoke collateralised debt obligation (CDO) correlations from standard index tranche correlations

A collateralised debt obligation (CDO) involves creating a portfolio of fixed-income securities or credit derivatives and repackaging the underlying risk of the portfolio by partitioning it into tranches. The tranches are created to suit the risk-return profiles of a wide range of investors. In cash CDOs, the portfolio of underlying securities consists of cash instruments, that is, bonds, loans, asset-backed securities and so on; these constitute the asset side of the structure. The liability

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