Bespoke portfolio (CDO)

Bespoke portfolios almost invariably have numbers of reference securities similar to those of the major credit indices – 100 to 125 reference securities – but bespoke portfolios can include reference securities that have highly correlated default probabilities, either because they are issued by different subsidiaries of the same parent company, because they include closely related but separate companies, or because the bespoke portfolios include much higher concentrations in single industries than occurs in credit indices.

[5] CDO tranches linked to bespoke portfolios continued to trade after the financial crisis of 2007–08 but in considerably reduced amounts.

[6] As mentioned above, the key advantage to investors was that it allowed them to specify the reference securities in the bespoke portfolio as well as the tranche's attachment and detachment points and other characteristics.

A report from the Banque de France stated that: "this avoids some of the dangers of traditional CDO structures, such as the risks of moral hazard or adverse selection in the choice of the names in the portfolio ...".

Because CDOs linked to bespoke portfolios are, by their nature, only held by one or a very small number of investors, there is no liquid market where they can be bought, sold or valued.

Brigo, Pallavicini and Torresetti summed up the problem in their 2010 book as follows: "Bespoke corporate pools have no data from which to infer default "correlation" and dubious mapping methods are used.

The aforementioned 2005 Banque de France report pointed out that CDO tranche issuance referencing bespoke portfolios "may have a major impact on credit spreads due to their leverage".

This in turn meant that changes in observed correlations on index tranches caused very large scale buying of CDS protection by swaps dealers during the financial crisis, increasing instability and illiquidity.