Another view on the pricing of MBSs, CMOs and CDOs of ABS

Jean-David Fermanian


Introduction to 'Lessons from the Financial Crisis'


The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can be Learned?


Underwriting versus Economy: A New Approach to Decomposing Mortgage Losses


The Shadow Banking System and Hyman Minsky’s Economic Journey


The Collapse of the Icelandic Banking System


The Quant Crunch Experience and the Future of Quantitative Investing


No Margin for Error: The Impact of the Credit Crisis on Derivatives Markets


The Re-Emergence of Distressed Exchanges in Corporate Restructurings


Modelling Systemic and Sovereign Risks


Measuring and Managing Risk in Innovative Financial Instruments


Forecasting Extreme Risk of Equity Portfolios with Fundamental Factors


Limits of Implied Credit Correlation Metrics Before and During the Crisis


Another view on the pricing of MBSs, CMOs and CDOs of ABS


Pricing of Credit Derivatives with and without Counterparty and Collateral Adjustments


A Practical Guide to Monte Carlo CVA


The Endogenous Dynamics of Markets: Price Impact, Feedback Loops and Instabilities


Market Panics: Correlation Dynamics, Dispersion and Tails


Financial Complexity and Systemic Stability in Trading Markets


The Martingale Theory of Bubbles: Implications for the Valuation of Derivatives and Detecting Bubbles


Managing through a Crisis: Practical Insights and Lessons Learned for Quantitatively Managed Equity Portfolios


Active Risk Management: A Credit Investor’s Perspective


Investment Strategy Returns: Volatility, Asymmetry, Fat Tails and the Nature of Alpha

Since the 1980s, securitisation has fuelled the creation of multiple families of financial products that we will call “structures”. The reasons for this boom are well known and have been widely studied in the literature: see, for example, Fabozzi and Kothari (2008) or Takavoli (2008). Apparently, most of these structures follow the same logic: gather more-or-less tradeable assets together in an ad hoc vehicle, create different tranches that would provide different risk/return profiles for different classes of investors and sell them.

Let us keep in mind the two icons of this business.

    • Synthetic corporate collateralised debt obligations (CDOs), based on about 100 credit default swaps: the main underlying risks are the potential default events of the underlying firms, their spread variations and the recovery amounts after any default.
    • Asset-backed securities (ABSs): cash instruments based on thousands of individual loans coming from retail banking. Here, losses can occur due to prepayment (some underlying assets can be repaid more quickly than expected, inducing a marked-to-market loss for investors) or to default risk (inability to reimburse some coupons or

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