On the Relative Pricing of Long-Maturity Index Options and Collateralized Debt Obligations

We investigate a structural model of market and firm-level dynamics in order to jointly price long-dated S&P 500 index options and CDO tranches of corporate debt. We identify market dynamics from index option prices and idiosyncratic dynamics from the term structure of credit spreads. We find that all tranches can be well priced out-of-sample before the crisis. During the crisis, however, our model can capture senior tranche prices only if we allow for the possibility of a catastrophic jump. Thus, senior tranches are nonredundant assets that provide a unique window into the pricing of catastrophic risk.


Published in:
Journal Of Finance, 67, 6, 1983-2014
Year:
2012
Publisher:
Hoboken, Wiley-Blackwell
ISSN:
0022-1082
Keywords:
Laboratories:




 Record created 2013-02-27, last modified 2018-03-17


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