Journal of Credit Risk

Risk.net

A correlation estimation method for CDO equity

Jeffrey Prince

ABSTRACT

Investors desire a simple but robust method of estimating return correlation between collateralized debt obligation (CDO) equity and other investments. Existing correlation estimation methods suffer from a dearth of data and complicated models. The proposed method, called correlation transitivity, permits investors to estimate correlation between CDO equity and alternative investments from correlation between the CDO collateral and the alternative investments. Correlation transitivity is simple to use and represents a powerful alternative to existing correlation estimation methods.

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