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An analytical approach for systematic risk sensitivity of structured finance products

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  • Arndt Claußen
  • Sebastian Löhr
  • Daniel Rösch

Abstract

The global financial crisis has shown that many financial institutions dealing with credit derivatives were exposed to severe unexpected losses. This indicates that systematic influences are decisively underestimated particularly with regard to structured products like securitized tranches of collateralized debt obligations. Our analytical study addresses these systematic effects: We provide a simple model which allows a closed-form comparison of both bonds and tranches with respect to their systematic risk. We demonstrate that the exposure to systematic risk of tranches may be many times higher than the exposure of bonds, even if both products share the same rating grade, e.g., an ‘AAA’ rating, measured by either default probability or expected loss. Particularly in economic downturns, default rates of tranches may be multiples of those of bonds. Our results help understand high default rates of tranches during the financial crisis and show that classical ratings are insufficient metrics for measuring risks of structured products. Copyright Springer Science+Business Media New York 2014

Suggested Citation

  • Arndt Claußen & Sebastian Löhr & Daniel Rösch, 2014. "An analytical approach for systematic risk sensitivity of structured finance products," Review of Derivatives Research, Springer, vol. 17(1), pages 1-37, April.
    • Handle: RePEc:kap:revdev:v:17:y:2014:i:1:p:1-37
    DOI: 10.1007/s11147-013-9089-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit derivatives; CDO; Bond; Ratings; Systematic risk; C16; C50; G21; G24;
    All these keywords.

    JEL classification:

    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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