Why CDOs Work

The growth of the structured credit market gave rise to many complex collateralised debt obligation (CDO) structures and, prior to the beginning of the global financial crisis in 2007, the CDO was seen as a successful financial innovation. However, CDOs have since been blamed for partly causing the crisis and there has been much criticism directed at banks and rating agencies. This article explains how the economics and therefore success of a CDO are related to a transformation of credit risk but that this also creates problems such as greater systematic risk in senior tranches