assets in 10 sectors. We then gradually add buckets of short positions, from 10 percent of the long notional amount up to 200 percent of the long notional amount. We consider "A" and "B" quality assets for the short buckets. Figure 11.2 shows the impact of adding short positions on the credit enhancement (CE) required, in order to achieve a "AAA" and "BBB" rating from Standard & Poor's. The left exhibit shows the absolute CE, whereas the right exhibit shows the relative CE as a fraction of the long only "A" rated portfolio notional (put another way, the right panel shows the CE with shorts scaled by the CE needed without shorts).

The grey line shows the CE required to achieve an "AAA" rating when different amounts of "A" shorts are added, whereas the greyline shows the same statistic when "B" shorts are added instead. The dotted and dashed line shows the same statistic for a target "BBB" rating. What is apparent is that the required CE reduces with the introduction of a short bucket and, as expected, that this reduction depends highly on the credit quality of the short portfolio. When "B" quality short positions are added, we see a stark decline in required subordination, resulting from significantly higher PDs of NIG assets compared to investment grade, (IG) ones.

Figure 11.3 repeats this exercise, but now for a long portfolio of "BB" quality, and we consider shorting "BB" and "B" quality assets this time.

Although the observations of Figure 11.2 also hold for this experiment, we can further observe that the relative decline in CE when shorts of the same credit quality as longs are introduced is higher for low credit quality portfolios.

In addition to shorting single-name exposures, short positions can also be taken in synthetic CDO tranches. Going long and short tranches allows one to execute directional trades where a (speculative) view is taken

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