This thesis is about the analysis on the valuation of CBO. The important process valuing CBO is to identify the default probability, recovery rate of the risky bonds as well as default correlation between underlying securities.
As these three factors affect the cash flows of underlying risky bonds, the reduced-form model is adapted to analyze the cash flows of the underlying assets. Reduced-form model mainly focuses on the assumption that the price of securities reflects default probability and recovery rate if securities are actively traded in the market. On the other hand, time series data is used to get default correlation of the underlying assets.
As one may think, default correlation is the major factor to value the cash flow of the CBO’s underlying assets as much as default probability and recovery rate affects their cash flows.
