Yale ICF Working Paper No. 0706
Collateralized Debt Obligations and Credit Risk
Transfer
Douglas J. Lucas, Executive Director, CDO Research, UBS
Laurie S. Goodman, CoHead, Global Fixed Income Research, UBS
Frank J. Fabozzi, Professor in the Practice of Finance, Yale University,
School of Management and International Center for Finance
This paper can be downloaded without charge from the
Social Science Research Network Electronic Paper Collection:
http://ssrn.com/abstract=997276
Collateralized debt obligations and credit risk transfer
Douglas J. Lucas, Executive director and head of CDO Research, UBS
Laurie S. Goodman, Managing director and CoHead of Global Fixed Income Research, UBS
Frank J. Fabozzi, Professor in the Practice of Finance, School of Management, Yale University
ABSTRACT
Several studies have reported how new credit risk transfer vehicles have made it easier to reallocate large
amounts of credit risk from the financial sector to the nonfinancial sector of the capital markets. In this
article, we describe one of these new credit risk transfer vehicles, the collateralized debt obligation.
Synthetic credit debt obligations utilize credit default swaps, another relatively new credit risk transfer
vehicle.
Financial institutions face five major risks: credit, interest rate, price, currency, and liquidity. The
development of the derivatives markets prior to 1990 provided financial institutions with efficient vehicles
for the transfer of interest rate, price, and currency risks, as well as enhancing the liquidity of the
underlying assets. However, it is only in recent years that the market for the efficient transfer of credit risk
has developed. Credit risk is the risk that a debt instrument will decline in value as a result of the
borrower’s inability (real or perceived) to satisfy the contractual terms of its borrowing arrangement. In the
case of corporate debt obligations, credit risk encompasses default, credit spread, and rating downgrade
risks.
The most obvious way for a f