Sunday, October 11, 2009

Friendly Reminder

Now that OTC derivatives reform is back in the news, with all manner of hysterical claims about derivatives sure to follow, I just want to throw out this friendly reminder: Collateralized debt obligations (CDOs) are not derivatives. That is all.

16 comments:

Anonymous said...

Lots of people want to make them illegal.

Now, wouldn't that be an interesting development?

I read a comment by some CDS guy who said the CDS market has worked very well this year, and he credited Geithner's work on the CDS market while at the NYFed as one reason why.

Anonymous said...

Its true! When will people stop calling CDOs (and sometimes even securitization) "derivatives??

David Harper said...

This refers to the idea these are securities, I assume? I hear you...just curious if you have a link to some more background on this (I tried searching your blog; love the blog, btw!)...is there legal reasoning here? would love to get beneath the semantics b/c, as you know, many qualified folks put them in credit derivatives bucket. Just wondering if there is a meaningful distinction at play here or an uninteresting semantic debate. Thanks, David Harper @ bionicturtle.com

jck said...

i do put them in the derivatives bucket as do most books on the subject.
CDOs are strictly speaking (mostly, not all) asset-backed securities, but the tranches are priced like derivatives, with the premium over libor of a CDO tranche closely related to a CDS and determined with the same technique, copulas etc...

Anonymous said...

you're technically correct, but barely so.

they are synthetic securities.

David Harper said...

I tend to agree with jck: as a practical matter, we treat the tranches of a synthetic CDO a lot like credit derivatives functionally, so I don't get the "it's not a derivative" fuss.

Anonymous said...

There are cash and synthetic CDOs, so synthetic CDOs are derivatives (please don't tell the regulators that).

Anonymous said...

It's my impression that lawyers see CDOs as securities, not derivatives.

The problem being that there is no logical reason for the distinction, so textbooks rarely focus on legal distinctions (that are not necessarily very well defined anyhow).

M said...

That is why in IAS you are required to separate the `embedded derivative`; ie a security can have a link to a derivative that needs hedging and therefore falls under hedgeaccounting rules.
Sorry for not being exact legally and technically, but it has been a long time since I had to do with it.

Cheap RS Gold said...

I tend to accede with jck: as a applied matter, we amusement the tranches of a constructed CDO a lot like acclaim derivatives functionally, so I don't get the "it's not a derivative" fuss

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