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noun 1. Finance.
- one part or division of a larger unit, as of an asset pool or investment: The loan will be repaid in three tranches.
- a group of securities that share a certain characteristic and form part of a larger offering: The second tranche of the bond issue has a five-year maturity.
2. any part, division, or installment: We've hired the first tranche of researchers.
verb (used with object), tranched, tranching. 3. Finance. to divide into parts: tranched debt; A credit portfolio can be tranched into a variety of components that are then further subdivided.
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Why is the spread of an equity CDO tranche decreasing with correlation?
When you increase correlation, you are increasing the probability of having very large losses, as well as the probability of having no loss at all. So, you are increasing the probability that senior tranches might experience significant losses but also the probability that the equity tranche is left untouched. As a consequance the spread on the latter decreases.
What is the base correlation in a credit derivative pricing model?
While compound correlation is the correlation found by calibrating the Gaussian copula model to the price of a CDO tranche (for example 3-6%), base correlation is found by calibrating to the price of a first loss tranche, i.e. to the sum of all tranches up to an attachment point (for example 0-6%, the sum of 0-3% and 3-6%). The curve of correlations obtained by calibrating to first loss tranches turns out to be much smoother and more stable than that obtained by calibrating to plain tranches.
What is default correlation?
1. Its the likelihood of a domino effect occurring within a tranche of a CDO. If all the companies in a CDO are in the automobile industry, and one begins to fail and therefore is unable pay its debts, there is a good chance that it might be something in the automobile industry that is causing these companies to falter. Therefore if on company fails, the probability of others failing increases.
