Research On Risk Measurement Of CDO

As a stylized representative of structured products, Collateralized Debt Obligation (CDO) has developed rapidly since the beginning of 21 century, with a fast growth of trading scale and varieties. While after the outburst of the subprime crisis in 2007 and subsequent financial crisis, the development of CDO markets is brought to a standstill. The breakout of the crisis discloses a basic fact that research institutes and participants of structured products market, have not fully recognized and measured the risk of structured products. At the same time, China, as an emerging market country which is lagged in financial development, began to explore and launch a pilot project of structured products in 2005. Up to now, most commercial banks have issued some structured products. Basing on aforementioned view, we can conclude that CDO will not step down from the stage of history, but continue to develop stably basing on the lessons from the subprime crisis and measuring the risk correctly. This paper chooses to research on risk measurement of CDO and has constructed a framework of risk analysis and risk measuring models of CDO.The core of this paper tries to solve the three key problems of risk measuring of CDO. Firstly, In order to prevent information irrelative with correlation from influencing on the estimation of correlation when calculating asset return correlation from stock prices data, this paper put up with FGARCH-ST, FGARCH-SGED and FGARCH-NIG to capture the stylized characteristics of time series of log return of stock prices. And then estimate the correlation of residuals using Copula functions. Empirical analyses show that the results of FGARCH-NIG are best. Secondly, For the sake of capturing the stylized features of loss distribution of credit portfolio, such as fat-tail and skewedness, this paper constructs NIG-Copula factor model, double-NIG-Copula factor model and triple-NIG-Copula factor model basing on mixture- distribution-hypothesis and Vasicek model. Empirical analyses show that NIG-Copula factor model is not only semi analytical and compact framework, but also better to describe the fat tail, skewedness and tail correlation of the loss distribution, comparing with CreditMetrics, which is standard model to measure credit portfolio risk. These models contribute to estimating extreme VaR accurately. Thirdly, this paper puts forward a risk measuring model of tranches basing on analyzing full cash flow and measures the tail risk using all information about cash flow.This paper also explores the definition of structured products and credit ratings made by main international credit rating agencies. The fast development of structured products leads to a great variety of products and a confusing nomenclature. It is hard to understand these complex financial products and read relative statistical data. This paper gives a uniform definition by analyzing structure and risk characteristics of structured products. As an important complement of our research, this paper explores credit rating on CDO by main international credit rating agencies。Model risk, rating arbitrage, conflict of interest, and competition are analyzed mainly. We get the reason why the risk of CDO has not been understood fully from the rating angle.This paper is an exploring research on the risk of CDO under the background of the aftermath of financial crisis not calming down, global CDO markets keeping a standstill, while structured products developing fast in China. It is the only way to develop CDO market in lagged and developing countries on the precondition of utilizing advantages of backwardness fully, learning a lesson of CDO market in developed countries and measuring the risk of CDO correctly. The models proposed in this paper can be extended to pricing of CDO.