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Correlation Breakdown in the Valuation of Collateralized Fund Obligation

Unai Ansejo, Marcos Escobar, Aitor Bergara and Luis Seco
The Journal of Alternative Investments Winter 2006, 9 (3) 77-88; DOI: https://doi.org/10.3905/jai.2006.670101
Unai Ansejo
A doctoral student at Univerisdad del Pais Vasco in Bilbao, Spain.
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  • For correspondence: unai.ansejo@consulnor.com
Marcos Escobar
An assistant professor in the Department of Mathematics at Ryerson University in Toronto, Ontario, Canada.
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  • For correspondence: escobar@ryerson.ca
Aitor Bergara
A professor in the Department of Physics at Univerisdad del Pais Vasco in Bilbao, Spain.
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  • For correspondence: a.bergara@e.hu.es
Luis Seco
A professor in the Department of Mathematics at University of Toronto in Toronto, Ontario, Canada.
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  • For correspondence: seco@math.toronto.edu
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Abstract

In a collateralized fund obligation (CFO) several hedge funds are pooled in a fund that is in turn, securitized. Since the first securitization of a fund of hedge funds, launched in June 2002, these products haven't had much impact among investors. This is not surprising considering that it is very difficult to predict the credit solvency of each tranche of the securitization and therefore its valuation. In this article a particular CFO is analyzed in an analytical pricing framework, capturing the correlation breakdown and the leptokurtic phenomena characteristics of hedge funds. The results show that due to a lack of transparency which is common in hedge funds, confidence intervals in probabilities of default and credit spreads, are high enough to burden CFO proliferation.

TOPICS: Real assets/alternative investments/private equity, credit risk management, statistical methods

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The Journal of Alternative Investments
Vol. 9, Issue 3
Winter 2006
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Correlation Breakdown in the Valuation of Collateralized Fund Obligation
Unai Ansejo, Marcos Escobar, Aitor Bergara, Luis Seco
The Journal of Alternative Investments Dec 2006, 9 (3) 77-88; DOI: 10.3905/jai.2006.670101

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Correlation Breakdown in the Valuation of Collateralized Fund Obligation
Unai Ansejo, Marcos Escobar, Aitor Bergara, Luis Seco
The Journal of Alternative Investments Dec 2006, 9 (3) 77-88; DOI: 10.3905/jai.2006.670101
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