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Valuing Toxic Assets : An Analysis of CDO Equity

Author: Francis A Longstaff; Brett Myers
Publisher: Cambridge, Mass. National Bureau of Economic Research 2009.
Series: Working paper series (National Bureau of Economic Research), no. w14871.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
How does the market value complex structured-credit securities? This issue is central to understanding the current financial crisis and identifying effective policy measures. We study this issue from a novel perspective by contrasting the valuation of CDO equity with that of bank stocks. This is possible because both CDO equity and bank stock represent levered first-loss residual claims on an underlying portfolio of  Read more...
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Details

Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Francis A Longstaff; Brett Myers
OCLC Number: 1027286012
Notes: April 2009.
Description: 1 online resource.
Details: Mode of access: World Wide Web.
Series Title: Working paper series (National Bureau of Economic Research), no. w14871.
Responsibility: Francis A. Longstaff, Brett Myers.

Abstract:

How does the market value complex structured-credit securities? This issue is central to understanding the current financial crisis and identifying effective policy measures. We study this issue from a novel perspective by contrasting the valuation of CDO equity with that of bank stocks. This is possible because both CDO equity and bank stock represent levered first-loss residual claims on an underlying portfolio of debt. There are strong similarities in the two types of equity investments. Using an extensive data set of CDX index tranche prices, we find that the discount rates applied by the market to bank and CDO equity are very comparable. In addition, a single factor explains more than 64 percent of the variation in bank and CDO equity returns. Although banks are presumably active credit-portfolio managers, we find that bank alphas are significantly negative during the sample period and comparable in magnitude to those of more-passively-managed CDO equity. Both banks and CDO equity display significant sensitivity to "shadow banking" factors such as counterparty credit risk, the availability of collateralized financing for debt securities, and the liquidity of the derivatives market. A key implication is that we may be able to value "toxic" assets using readily-available stock market information.

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Primary Entity<\/h3>\n
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