Collateralized Commodity Obligations: Rating and Risk Assessment

Posted: 2 Oct 2012

See all articles by Svetlana Borovkova

Svetlana Borovkova

Vrije Universiteit Amsterdam - Faculty of Economics and Business Administration

Hidde Bunk

SNS Reaal

Willem-Jan de Goeij

affiliation not provided to SSRN

Dimitar Mechev

NIBC Bank N.V.

Dirk Veldhuizen

affiliation not provided to SSRN

Date Written: February 2, 2012

Abstract

In this article we address risk characteristics and rating of Collateralized Commodity Obligations (CCO), which are recently devised structured products similar to the Collateralized Debt Obligation (CDO). Commodities as an asset class have been in the spotlight of investors’ attention for the last decade. CCOs, which are fixed income instruments, provide fixed income investors an exposure to commodity markets. The underlying assets of a CCO are Commodity Trigger Swaps (CTS), similar to a Credit Default Swap, but instead of a default, a “trigger” occurs when a commodity price reaches a certain pre-set level.

Rating agencies have used their CDO evaluators to rate CCOs; however, particular characteristics of commodity prices and an abundance of historical price data for commodities render such an approach questionable. Recently, S&P has withdrawn their ratings for CCOs, which may be linked to some concerns regarding their rating approach.

We examine the historical performance of CCOs and propose two novel approaches to their rating. The first is a flexible multivariate parametric model for commodity prices: a mean-reversion model with correlated trends. The second approach is close in spirit to the historical simulation method for risk management and is based on the block bootstrap technique. We apply both approaches to an example of a CCO and compare the results to the ratings provided by the rating agencies. We find that:

* Simulated ratings are sensitive to the model assumptions.

* The default probabilities resulting from the agencies’ ratings underestimate both historically observed and bootstrap-simulated default probabilities.

* The non-parametric approach most closely matches the historically observed probabilities of default. The results demonstrate the benefit of a data-driven, non-parametric modelling approach to rating CCOs.

Keywords: structured product, commodities, rating, bootstrap, mean reversion

JEL Classification: C14, C15, C32, G13

Suggested Citation

Borovkova, Svetlana and Bunk, Hidde and Goeij, Willem-Jan de and Mechev, Dimitar and Veldhuizen, Dirk, Collateralized Commodity Obligations: Rating and Risk Assessment (February 2, 2012). Available at SSRN: https://ssrn.com/abstract=2154916 or http://dx.doi.org/10.2139/ssrn.2154916

Svetlana Borovkova (Contact Author)

Vrije Universiteit Amsterdam - Faculty of Economics and Business Administration ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Hidde Bunk

SNS Reaal ( email )

Hojel City Center
Croeselaan 1, Building A
Utrecht, NL 3521
Netherlands

Willem-Jan de Goeij

affiliation not provided to SSRN ( email )

Dimitar Mechev

NIBC Bank N.V. ( email )

Carnegieplein 4
Den Haag, 2517KJ
Netherlands

Dirk Veldhuizen

affiliation not provided to SSRN ( email )

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