Structured Credit Index Products and Default Correlation Harvard Case Solution & Analysis

In mid-2003, Morgan Stanley and JPMorgan launched a series of structured credit products, which have been in contact with the correlation in credit risk of firms underlying the TRAC-X index: tranched TRAC-X NA, tranched TRAC-X Europe, and options to as TRAC-X NA and TRAC-X Europe. The values ​​of these TRAC-X derivatives identified some key parameters: the probability of default of each of the firms considered in the index, the rate of recovery of major corporate debt in case of default, and the correlation between the credit risk of major companies (plus the value of trac-x option was also influenced by volatility of the CDS premiums). Tranched TRAC-X and other tranched products often quoted in the market at prices that were expressed by the implied correlation parameters. Among the issues facing the Morgan Stanley Lewis O'Donald was due "means the ratio of" quotations for tranched products. Taken at face value, quotes available in the market seemed to show that different tranches on the same underlying index traded company on different correlation implies the default. The market prices of various tranches implies different correlations default the same set of core businesses - which means that the credit protection and the same set of core businesses can be bought or sold at prices that suggest that the default base of firms were correlated differently with terms of the various tranches. This correlation skew on various tranches of TRAC-X represented form of pricing discrepancies. "Hide
by Darrell Duffy, Erin Yurday Source: Stanford Graduate School of Business 26 pages. Publication Date: February 29, 2004. Prod. #: F269-PDF-ENG

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