European Institute for Statistics, Probability, Stochastic Operations Research
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New Rating Models for Asset Backed Securities (ABS's)

The project is funded by the European Investment Bank University Research Sponsor (EIBURS) programme “Quantitative Analysis and Analytical Methods to Price Securitization Deals” and is implemented in cooperation with the European Investment Bank, Luxembourg, and Creative Capital Partners, Stockholm, Sweden.

ABS's and their rating is a fundamental part of the development of the current (2008) credit crisis. The fact that these financial instruments received very high ratings has given investors a false impression of “riskless” investment opportunities where losses are very unlikely. The so called AAA rated products have, through a domino effect of losses, proven not to meet up with the AAA criteria of very safe investments. Together with our industrial partners we investigate the existing models used by the rating agencies (Standard and Poor’s, Moody’s, Fitch). The standard models rely heavily on the use of the Normal distribution and on the Gaussian copula approach. These models have proven not to be able to correctly take into account the extreme events in and shock-driven nature of the world they were set out to describe. The objective of the project is to develop models that can describe extreme events, shocks and crash-scenarios, by using Extreme-value-theory, LÚvy processes and advanced dependence models.

The focus of the project is on the quantitative modeling, analysis and assessment of important risks in Asset Backed Securities and other securitization deals and can be divided into five parts:
1. Establish a theoretical framework for the analysis of ABS's
2. Develop and investigate new models for the rating of ABS's - taking into account crash scenarios, extreme events, lessons from the credit crises, etc.
3. Analyze typical cash flow features and waterfall structure
4. Investigate model risk on rating, WAL, IRR, etc.
5. Mark-to-model of ABS deals

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