A Bottom-up, Reduced Form Credit Risk Model Approach for the Determination of Collateralized Loan Obligation Capital

January 2023

Robert Jarrow[1]

Donald R. van Deventer[2]

Abstract

This paper uses a bottom-up, reduced form credit risk model with hazard rate estimated default probabilities to compute various collateralized loan obligation (CLO) tranches’ loss probabilities and capital factors. It is shown that with respect to the loss probabilities, credit rated CLO tranches are less risky than comparably rated corporate bonds. In addition, a similar argument can be made that corporate debt loss rates will be on average larger than an equally rated CLO tranche’s loss rate. And, with respect to the capital factors, it is shown that NAIC capital factors are typically larger than value-at risk based capital factors computed using a bottom-up, reduced form credit risk model.

The full text of the article, updated February 16, 2023, is available here:

Footnotes

[1] Samuel Curtis Johnson Graduate School of Management, Cornell University, Ithaca, N.Y. 14853 and the SAS Institute Inc.; Email: raj15@cornell.edu.

[2]  SAS Institute Inc.