Stress-testing CDOs

Abstract

Analyses regarding the responsibility of risk management for the current credit crisis have found a lack of stress tests as one important issue. In this article, we argue that stress tests are an even more important risk management tool with structured finance products such as collateralized debt obligations. We explain why the specific risk profile of such assets requires dynamic modeling. In an extensive case study, a stress-test comparison is made between portfolios including conventional bonds and structured products. The results clearly show the increased risk contribution of structured products which can only be revealed explicitly in a dynamic view.