What is a collateralized debt obligation (CDO)?

Butters 19 Mar 2008 Very Helpful! Thanks. One request: can you explain further why correlation among the the underlying assets would be an important factor. As I understand it default correlation could be very high but if the overall level of default is low, then why would that matter to the senior tranche holders? David Harper, CFA, FRM, CIPM 20 Mar 2008 Butters, Thanks for liking! You are of course correct: probability of default (PD) is key. Lately, sage quant gurus have been saying “all this fuss over correlation doesn’t matter if you don’t get the PD right” in so many words. However, defaults may matter to senior tranche note holder because, EVEN IF DEFAULTS DON’T REACH THEM, the value of their tranche can still fall (or plummet, in the case of subprime). It’s not only default that matters, but CREDIT DETERIORATION. This is largely what’s happened with subprime paper: super senior tranches plummetted in value, not really because defaults reach them but rather their subordination ...  more