What are bespoke CDS portfolios and how do they differ from standardized indices?

Question

AcadiFi · Accepted Answer

Bespoke CDS portfolios are customized synthetic credit baskets for specific investors, contrasting with standardized indices that have fixed constituents...

Unlock with Scholar — $19/month

Get full access to all Q&A answers, practice question explanations, and progress tracking.

Start 7-Day Free Trial Compare Plans

No credit card required for free trial

The typical structure: Ariadne Structured Credit hires a dealer to create a bespoke with $500M notional across 100 names weighted by investor preferences. The dealer sells protection on each name (long credit risk) and simultaneously structures tranched CDS on the portfolio, selling the equity to hedge funds, mezzanine to asset managers, and super senior to banks or insurers. The dealer earns structuring fees and warehouses residual risk.

Pre-2008, bespokes and CSOs (collateralized synthetic obligations) grew explosively because: (1) super senior tranches offered yield pickup over similarly rated corporates, (2) regulatory capital treatment favored AAA-rated super seniors, (3) banks could achieve rating arbitrage, (4) investors could customize exposure not available in standard indices. Notional volumes reached trillions.

Post-crisis, the bespoke market contracted dramatically as: regulatory capital rules hardened, rating agencies tightened correlation assumptions, accounting treatment changed, and the failure of models (Gaussian copula with single correlation) during clustered defaults destroyed confidence. Today bespokes exist but in much smaller volume, mostly for sophisticated institutional investors. CFA candidates should understand these as examples of how mispriced correlation can cause systemic issues.

What are bespoke CDS portfolios and how do they differ from standardized indices?

Master Level III with our CFA Course

Related Questions

Practice Questions