On the Relative Pricing of Long Maturity Index Options and Collateralized Debt Obligations
Coauthor(s): Robert Goldstein, Fan Yang.
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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 non-redundant assets that
provide a unique window into the pricing of catastrophic risk.
Source: Journal of Finance
Collin-Dufresne, Pierre, Robert Goldstein, and Fan Yang. "On the Relative Pricing of Long Maturity Index Options and Collateralized Debt Obligations." Journal of Finance 67, no. 6 (December 2012): 1983-2014.