Quantitative analysts are trying to figure out how to tranche constant proportion debt obligations in order to work credit correlation plays into the structures. As part of the effort, which would slice a CPDO into riskier pieces rated below AAA, some analysts said they are looking at applying constant proportion portfolio insurance on top of such deals as an extra form of protection to support a high rating for the structures.
In CPPI structures, exposure to the so-called risky asset class decreases when the asset class loses value and increases when it gains. This leveraged exposure is the other way round in CPDOs, where assets invested in the risky asset class--which in this new structure would be credit tranches--are increased when it underperforms and decreased when it is recording high returns.
Quants are now trying to combine the two. In a possible structure, investors' cash would be put into a CPPI note and split between a risky portfolio that invests in a tranched CPDO and a portfolio of safe assets such as Treasuries. The idea is that the investor would be protected against losses in the CPDO but at the same time have exposure to its upside.
A rating agency official currently rating around 10 CPDO deals noted that this development would be the third generation of the product and although he had heard talk about it he has not yet seen any proposals. Most firms are focused on issuing AAA-rated managed and static deals, he added.
