ROBERTO TORRESETTI (Grupo Banco
ANDREA PALLAVICINI (Banca Leonardo)
This paper presents the analytical structure of a specific CPDO contract and make a comparison with CPPIs. We then review the standard criteria adopted by rating agencies to assess the riskiness of CPDOs. We introduce one important modification to these assumptions: a loss distribution in the objective measure with bumps. We hint at the evidence found in literature, Longstaff et al. (2007), that we believe points in the direction of bumps in the loss distribution being not just a risk premium associated to senior tranches. In the framework of our GPCL model, Brigo et al. (2007), we estimate the size of the bumps in the loss distribution under the objective measure. We show that the riskiness of CPDOs is substantially impacted (increased) by the introduction of the bump feature in the loss distribution. In the same spirit of Linden et al. (2007), we also assess the CPDO riskiness stressing conservatively the criteria: roll-down-benefit and mean reversion parameters used when simulating the credit index spread. We also show that the gap-risk option embedded in CPDO structure increases considerably under the GPCL approach.