Master CDO Dissected

Abstract

Building upon an analysis of the loss distribution of a CDO2 in comparison to the loss distribution of a ST CDO in a previous article in this journal, the authors highlight the risk profiles of a Master CDO to a CDO2 pool and an ABS CDO pool. The effects of correlation on the loss distribution of a Master CDO are explored varying the correlation within the ABS CDO pool and between the ABS CDO and credits in ST CDO pools. The authors are not recommending one structure over the other, but believe that investors should be cognizant of the different risk profiles of these structures. While all three products have positive attributes, investors need to pay closer attention to significant differences in the loss distributions of the three CDO types, as characterized overall shape, zero-loss probability, and tail.