Introduction and evolution of bespoke CDOs. pricing, risk management and market peculiarities

Abstract

This document is devoted, from a theoretical and empirical perspective, to the introduction and classification of Bespoke CDOs, the evolution of the modeling, pricing and risk management of the product over time, and the discussion of current market trends related to it. First, I gradually explain the Bespoke CDO mechanics and position it among other products from different categories. Then I review the Gaussian copula model with base correlations used as an industry standard for pricing and risk management, commenting at the same time what various authors put forward for and against the model and its alternatives. Finally, I expose as a possible and more sophisticated alternative the Consistent valuation through semi-analytical Monte Carlo simulation with many-to-one restriction proposed by (Li, 2010), describing simultaneously the present-day market size and situation.