Tranching and Pricing in CDO-Transactions

Abstract

This paper empirically investigates the tranching and tranche pricing of European securitization transactions of corporate loans and bonds. Tranching allows the originator to issue bonds with strong quality differences and thereby attract heterogeneous investors. We find that the number of differently rated tranches in a transaction is inversely related to the quality of the underlying asset pool. Credit spreads on tranches in a transaction are inversely related to the number of tranches. The average price for transferring a unit of expected default risk, paid in a transaction, is inversely related to the default probability of the underlying asset pool. The average price, paid for a tranche, increases with the rating of the tranche, it is higher for the lowest rated tranche and very high for AAA-tranches in true sale-transactions. It varies little across butterfly spreads obtained from rated tranches except for the most senior spread.