What's Wrong With CDO Models?

Watching the gruesome, global train wreck that is hedge funds heavily invested in collateralized debt obligations (pools of bonds, loans or other assets, the subprime mortgage pools being the ones in the most trouble today), we wonder, is something wrong with the models investment firms use to price and gauge the risk of these derivatives?Certainly, rating agencies such as Fitch are scrambling to re-grade these instruments. But within investment banks and hedge funds, are the pricing models programmed to generate only fantasy prices? Or are those who use the models fudging the data entered into them? And are risk models failing to spot potential problems in loan pools, or are they accurately assessing high risks that are overlooked by bankers who focus instead on high returns? Or is the subprime mortgage crisis so large and severe that no amount of conservative risk or pricing analysis could prevent investment firms from being affected?

We'll be doing a report on CDO risk and price modeling in our October issue. If you'd like to share any thoughts on this topic, please contact [email protected].