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Impact of intra-tranche default correlation on different CDO tranches

Thread starter #1
Hello.

I wonder if my understanding is correct with regards to the impact of intra-tranche default correlation on value of different CDO tranches.

1. Equity tranche: when correlation increases, the value of the tranche increases because now there is higher chance of the underlying assets surviving together.

2. Investment grade tranche: when correlation increases, the value of the tranche increases because the survival of the underlying assets within the investment grade tranches are taken as given. Now that the tendency of the underlying assets surviving together are even higher, the value of the tranche increases.

In addition, please let me know if I'm correct in understanding that in both cases above, the spread will decrease.

Thank you in advance!
 

brian.field

Well-Known Member
Subscriber
#2
We are talking about default correlation of the underlying assets.

Equity value increases as correlation increases. The highest rated tranche, or senior tranche, is the opposite; as correlation increases, its value decreases. The mezzanine tranche can exhibit either behavior.
 
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