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We build a benchmark for AAA-rated tranches of collateralized loan obligations (CLOs) using business development companies (BDCs), which hold a diversified portfolio of loans as CLOs do. BDCs are publicly listed, and their share price, equity volatility, and borrowing cost can be easily obtained. Applying a structural model to BDCs, we extract market-implied correlation in their loan portfolio, compare spreads on CLO tranches and BDC-implied benchmark, and find that observed large credit spreads on CLO senior tranches after the financial crisis are a fair reflection of the systematic risk of correlated loan defaults. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00097 .
Elkamhi et al. (Tue,) studied this question.