The cost of holding risk is a crucial concept for any corporation to understand. Most financial policy decisions, whether they concern capital structure, dividends, capital allocation, capital budgeting, or investment and hedging policies, revolve around the corporate costs of holding risk. These decisions can be made well only with a thorough understanding of how costly it is to originate and warehouse risk.
This issue is particularly acute for financial firms, since the origination and warehousing of risk constitutes their core value added. For these firms, capital is often their most expensive and important input in production. They deploy capital by holding a large number of financial risk positions that need to be evaluated. Moreover, these positions turn over and are competitively repriced far more often than the physical assets of non-financial firms. Unanticipated shocks to the demand for financial firms’ products can be planned for and actively protected against, unlike those for non-financial firms. For these reasons, financial firms have the greatest need to understand the costs and benefits of holding risk.
Minority-owned firms far surpassed the growth of all U.S. businesses, increasing 17 percent annually in the decade 1987 to 1997. This is six times faster than the annual growth rate of 3 percent for all businesses during that same decade, up from double the rate of all firms as of 1992 as noted in last year’s report2 (see Figure 1). Asian-owned firms increased in number by 18 percent per year. Latino-owned firms increased 23 percent per year, and black-owned firms increased 11 percent per year.
If viewed from the vantage point of sales, the results are similar. Sales across all firms rose 13 percent per year while they rose 34 percent for minority-owned firms during the same time period – more than twice the national average. For Asian-owned firms, sales rose 42 percent per year and for Latino-owned firms, sales rose 46 percent per year. For black-owned firms, sales rose 11 percent per year.
This paper addresses the risk analysis and market valuation of collateralized debt obligations (CDOs). We illustrate the effects of correlation and prioritization for the market valuation, diversity score, and risk of CDOs, in a simple jump-diffusion setting for correlated default intensities. ACDO isanasset-backed security whose underlying collater al is typicallya portfolio of bonds (corporate or sovereign) or bank loans.
