TY - JOUR T1 - CDO Equity Returns and Return Correlation JF - The Journal of Structured Finance SP - 42 LP - 53 DO - 10.3905/jsf.2004.426071 VL - 10 IS - 2 AU - Douglas J. Lucas AU - Laurie S. Goodman AU - Frank J. Fabozzi Y1 - 2004/07/31 UR - https://pm-research.com/content/10/2/42.abstract N2 - Equity in a collateralized debt obligation (CDO), called? CDO equity,? ?preferred shares,? or? preference shares,? represents a residual interest in the cash flow of the CDO's assets. CDO equity holders receive the difference between the cash flow of the CDO's assets and the cash flow necessary to pay the CDO's expenses and service its debt. Substantial research has been published on historic CDO equity returns, particularly with regard to the monthly volatility of equity returns, their Sharpe ratios, and the correlation of CDO equity returns to the returns of other assets. However, the calculation of these variables is fundamentally flawed because the secondary market for CDO equity is undeveloped. The authors show that the only historical data that provide insight into the future performance of CDO equity are the default and recovery of underlying CDO assets. The authors use available high-yield loan and structured finance asset default and recovery data to examine the implications for CDO equity. They show that the correlation of CDO equity returns and CDO underlying asset returns is a simple function of the levered and non-recourse nature of CDO equity. ER -