The Interface

CIRANO¶s CDO pricing module is built in a

C# framework. It¶s a stand-alone module
since no particular software is needed to use
it. It¶s a user-friendly tool.
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The Inputs
Let¶s start with the « Evaluation »
function of the Monte-Carlo simulations.

The user has to enter some of the main parameters of the CDO.
The CDO maturity (in years), the payment frequency (usually
quarterly) are examples of the required inputs. The current
example uses a CDO with 10 collaterals. It¶s possible to select a
higher number of assets. However, this will cost more in terms
of calculation time. 
The Inputs

The tranche to price has to be specified. The value,

in millions of dollars, of the upper and lower
boundaries have to be entered.

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The Inputs
Our module enables the use of specific data
matrices. The files have to be in a text or
spreadsheet format.

The risk-free rate and an asset default correlation

matrix are required. The value and the recovery rate
of each asset are also inputs of the model.

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The Inputs

The term structure of the Credit Default Swap is

also used in the model. It can be integrated
through a external file or modelled with a
Weibull function.
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The Inputs

It¶s now time to simulate. The Quasi-Monte-Carlo

technique has been added to our module. It
generates the same results as a typical simulation
while being more precise and requiring less
simulations. Ä
The Results
Many interesting results come out of the
simulations. The nominal value of the
tranche is the first output given. The
average upfront spread (in % per year)
is next. The upfront spread is the
payment exceeding 500 basis points.

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The Results

The loss of the tranche during the given period

is also available. So is its confidence interval.
The loss dispersion statistics such as the
standard deviation and the VaR are also
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displayed. All of these data are in basis points.
 Sensitivity Analysis
Once the results are obtained, it¶s possible to perform
sensitivity analyses. We want to determine the impact
on the spread and on the loss of a 1 basis point decrease
in the index.

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 Sensitivity Analysis
Our results show that a 1 basis point decrease in the value
of the index generates a 6.03 basis points spread increase
and a loss of 0.338% on the value of the tranche.

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The Interface
The Hull and White model (2004) is an important
feature of the CIRANO¶s CDO pricing module.
Major improvements have been realized in this
module in regard to calculation time. It¶s based on
Gaussian copulas.

The main characteristics of the CDO are in the upper section

of the interface. These characteristics are the CDO maturity,
the payment frequency and the number of assets.

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The Inputs

It¶s important to mention that this model can

price a CDO having 125 collaterals very
quickly. It¶s now also possible to price
simultaneously all the tranches of the CDO
without increasing the calculation time.

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The Inputs

Just like with the Monte-Carlo simulations, it¶s

possible to use external data matrices. These have to
be in text or spreadsheet format. The following
example will use Excel spreadsheets.

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The Inputs

The required inputs are mainly the same as the ones needed
for the Monte-Carlo simulations. The correlation file is a
vectorial file since the correlation is now calculated in
regard to the market. The recovery rate is also fixed for all
of the assets.
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 The Results

A few moments later, the results for

the seven tranches appear.
Four important statistics are
available for each tranche :
- The upfront value of the spread
(where applicable)
- The Cherubini spread
- The real spread
- The nominal loss each tranche
should suffer.

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Sensitivity Analysis

Just like with the Monte-Carlo simulations, spread and

loss sensitivity analyses in regard to index or correlation
movements can be perform. Here, we analyse the impact
of a 1 basis point movement in the index.

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Sensitivity Analysis

To get an overview of the relationship the spread and the loss

have with the index or the correlation, graphics are generated.
These are available for each of the analyses and can contain
the value of one tranche or the values of all tranches.

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The Interface

Reverse engineering can be perform with

the Monte-Carlo Simulations and the
Hull and White model.
This function makes it possible to find
the implied correlation or the implied
value of the index associated with the
loss or the spread of a tranche.

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The Inputs

This example will perform reverse engineering with the

Monte-Carlo simulations. The upfront value of the spread
found in the previous Monte-Carlo example will be used to
determine the implied correlation. The same inputs as the
ones used for pricing are necessary.
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The Results

The implied correlation found with this upfront spread

value is 0.3. This value is coherent with the one that has
been used to simulate the spread in the previous example.
Reverse engineering has then been efficiently performed.

 The Interface

The LHPM model may also be used to

price CDO tranches.

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The Inputs

The LHPM model determines the prices of the tranches

with the help of the base correlation of the CDO. It mainly
uses the same inputs as the two previous pricing models.


The Inputs

The model also uses the upfront value of the spread (represented
by a 500 basis points value) for the appropriate tranches and the
base correlation values of all the tranches.

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The Results
The following results are obtained : the fair spread, the
upfront fee, the spread and the loss suffered by the tranche.

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 The Interface

The LHPM model may also be used to

determine the compound and implied
correlations. It also prices exotic tranches.

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The Inputs

Using the spreads of the CDX tranches, it¶s possible to compute the
base correlation and compound correlation curves.

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 The Results
Once the calculations are over, the values of the two types of
correlation are obtained. Graphics display the associated curves.

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 Exotic Tranches
Now that we have determine the base correlation curve, we are
able to price exotic tranches with the LHPM model. This curve
allows us to determine the base correlation value for a tranche
having uncommon attachment point. To get this correlation, the
button « Compute correlations » has to be pressed.

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 Exotic Tranches
When we click on the « Tranche Pricing » button, the LPHM model
and the base correlation previously found are used to determine the
spread (in basis points and in upfront) of the exotic 0-2 tranche.

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 The Interface

We have added to our module a CDO

strategy analysis tool.

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The Components

At first, the historical values of the standard CDO tranches

quotes and of the proper index have to be loaded into the
module. An external file is used. Those tranches will be
used to build the strategies.
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The Components

The user now has to build the strategy. The position on the
tranche has to be specified (purchase or sale of protection) as
well as the amount invested in each position (notional in
millions of dollars).

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The Components

A few other inputs are necessary to perform the analysis of

the strategy. Those inputs are fixed for all of the tranches.

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Sensitivity Analysis

We can now perform sensitivity analyses. One will study the

value of the strategy following basis point changes in the value of
the index spread and another will look at the strategy¶s value after
movements in the asset default correlation.

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Sensitivity Analysis

The results of the analyses are displayed in graphics. This one

shows the marked-to-market value of our strategy following
movements in the index spread.

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Sensitivity Analysis

A similar graphic shows the impacts on the strategy of

changes in the asset default correlation.

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Sensitivity Analysis

It¶s possible to look at the impacts of defaults on these sensitivity

analyses. This kind of analysis can be performed by ticking the « One
index type analysis » box and by choosing the number of defaults the
CDO will suffer. If a strategy uses more than one standard CDO, the
CDO suffering the defaults has to be specified.

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Sensitivity Analysis

The graphic we obtain is similar to the previous ones. However, an

additional curve has been added. It represents the marked to market
value of the strategy following a movement in the index spread in
the case where 2 defaults have occurred.

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ack-Testing

The module enables the back-testing of the marked to market values of

the strategy. Entry and exit dates are displayed for this analysis. y
default, those dates are determined by the availability of the data
contained in the file that has been loaded. They can be modified.

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ack-Testing

Following the analysis, this graphic is obtained.