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Title: Subprime Crisis, Systematic Risk and Arbitrage
Author: Rajani, Asif Ali Kabiruddin
Advisor: Luis, Jorge Barros
Keywords: Subprime Crisis
Systematic Risk
Collateralized debt obligations (CDO)
Defense Date: May-2011
Publisher: Instituto Superior de Economia e Gestão
Citation: Rajani, Asif Ali Kabiruddin. 2011. "Subprime Crisis, Systematic Risk and Arbitrage". Dissertação de Mestrado. Universidade Técnica de Lisboa. Instituto Superior de Economia e Gestão.
Abstract: The financial market turmoil of 2007 and 2008 was the most severe recession seen after the Great Depression. The economic momentum, previous to the crisis, created a strong demand for AAA securities that was not available on single bond market. This motivated arrangers to issue high volumes of structured finance securities, collateralized by subprime Residential Mortgage-Backed Securities. Most of the AAA investors based their choices uniquely based on Credit Rating Agencies' assessment that taken into account Probabilities of Default or Expected Losses but mispriced the Systematic Risk. This fact created arbitrage opportunities for Asset-Backed Securities (ABS) and ABS Collateralized Debt Obligations (ABS CDO) arrangers. They exploited it by issuing securities with high levels of Systematic Risk. In this work I run ABS and ABS CDO simulations to exemplify how these instruments were structured to explore these features. To quantify the extent of the mispricing I compare a structured security with a single bond with the same rating. I use the results to exemplify the potential gains obtained by the arranger by taking advantage of the investor's blindness concerning Systematic Risk. I also approach other Structured Finance risks as parameter sensitivity and biased asset pool parameters in rating models.
Description: Mestrado em Matemática Financeira
Appears in Collections:BISEG - Dissertações de Mestrado / Master Thesis
DM - Dissertações de Mestrado / Master Thesis

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