From Moody’s late yesterday:
Moody’s places certain European CPDOs under review for downgrade
Approximately 854 million EUR debt securities affected.
Paris, September 04, 2008 — This review is prompted by the identification of a coding error in a model used for monitoring CPDOs that has been in use for approximately two months. The review will also consider the further widening of spreads on investment grade reference credits that affect these CPDOs since Moody’s last review.
That’s right, another error, in the new model. The impact of which is material, though not, apparently, as material as the error the Financial Times uncovered in May.
CPDOs aren’t actually that complex. They’re relatively straightforward, algorythmically speaking, to understand. The rules they abide by are fixed. The kind of strategies most Quants deal with are endlessly more complicated.
Rating CPDO’s though, is fiendishly difficult. Rating a CPDO requires relatively accurate modelling of the volatility of credit markets on a ten year basis. If a rating agency could come up with that, rating certainly wouldn’t be the economical use of its time.
The rating of a CDO – based on its structuring – is fairly easy to assign. But when you need to factor in correlation across tranches and mortgage perfomance, as with CPDOs, you’re talking again about assessing market risk. Rating then becomes not so easy.
Again then, a question: are rating agencies fit to rate?
And Moody’s, while you’re at it, some other things you might like to take a look at:
Your use of the Gaussian copula to model market pricesThe extremely low volatility cap you oddly applied to your index spread projections.Your default/correlation model. Corporate default rates are rising.
Revealing your actual methodologies to the market, not just the ones you want to be seen.
Related links
FT Alphaville exclusive: Moody’s error gave top ratings to debt products – FT Alphaville