Expected tail loss efficient frontiers for CDOS of bespoke portfolios under one-factor copula marginal distributions

Abstract

The global structured credit landscape has been irrevocably changed with the innovation of Collateralized Debt Obligations (abbreviated as CDOs). As of 2006, the volume of synthetic CDO structures outstanding grew to over 1.9 trillion. Understanding the risk/return trade-off dynamics underlying the bespoke collateral portfolios is crucial when optimising the utility provided by these instruments. In this paper, we study the behaviour of the efficient frontier generated for a collateral portfolio under heavy-tailed distribution assumptions. The convex and coherent credit risk measures, ETL and Copula Marginal ETL (abbreviated as CMETL), are used as our portfolio optimisation criterion. iTraxx Europe IG S5 index constituents are used as an illustrative example. © 2009 Springer Netherlands.