Structured Credit Index Products and Default Correlation  Case Solution

Tranched TRAC-X and other products that are tranched were frequently quoted in the marketplace at costs that were expressed through an implied correlation coefficient parameter. One of the problems facing Morgan Stanley's Lewis O'Donald was the consequence of the "tacit correlation" quotes on the tranched products.

The quotes accessible the marketplace appeared to suggest that distinct tranches on the exact same underlying index of companies were trading at distinct default correlations that were tacit. The prices in the market of different sections showed that distinct default correlations for the exact same set of fundamental companies--meaning that credit protection for the exact same set of fundamental companies could be purchased or sold at prices that presumed the default options of the fundamental companies were correlated otherwise from the perspective of different tranches. This correlation skew across the various TRACX tranches represented a kind of pricing disparity.

This is just an excerpt. This case is about FINANCE & ACCOUNTING

PUBLICATION DATE: February 29, 2004

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