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The Journal of Structured Finance

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CDO Equity

The Benefits of Diversification

Henry Fok and Terry L Benzschawel
The Journal of Structured Finance Spring 2007, 13 (1) 28-30; DOI: https://doi.org/10.3905/jsf.2007.684861
Henry Fok
A vice president at Citigroup Global Markets in New York, NY.
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  • For correspondence: henry.fok@citigroup.com
Terry L Benzschawel
A director at Citigroup Global Markets in New York, NY.
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  • For correspondence: terry.l.benzschawel@citigroup.com
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Abstract

Individual CDO equity deals typically have large annual returns, but also can exhibit high return volatility. Using historical cash returns, the authors demonstrate that investors can improve risk-adjusted returns from CDO equity by diversifying into multiple deals, both within and among collateral classes and vintages. A portfolio constructed with even a modest number of CDO equity deals substantially lowers cash return uncertainty over that for a single deal. A 20-deal portfolio decreases the inter-quartile return range by 80%. The marginal impact of CDO equity diversification diminishes rapidly beyond 20 issues in a portfolio. A CDO equity fund-of-funds structure provides an efficient means of accessing a diversified portfolio of CDO equity.

TOPICS: Credit risk management, CLOs, CDOs, and other structured credit, portfolio construction

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The Journal of Structured Finance
Vol. 13, Issue 1
Spring 2007
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CDO Equity
Henry Fok, Terry L Benzschawel
The Journal of Structured Finance Apr 2007, 13 (1) 28-30; DOI: 10.3905/jsf.2007.684861

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CDO Equity
Henry Fok, Terry L Benzschawel
The Journal of Structured Finance Apr 2007, 13 (1) 28-30; DOI: 10.3905/jsf.2007.684861
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