Abstract
Financial institutions with exposure to structured products need to value these securities and undertake scenario analysis, specified in terms of changes in economic variables. We introduce a top-down no-arbitrage model for structured products, with losses governed by Cox processes whose intensities depend on economic variables. We estimate the model using CDO data and find that spreads decrease with higher interest rates and stock market returns, and increase with the VIX. The VIX is the primary determinant of variation in tranche spreads. Model-implied risk premiums, probabilities of tranche losses and values-at-risk increase substantially during the financial crisis.
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