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Dynamic hedging of synthetic CDO tranches with spread risk and default contagion

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  • Frey, Rüdiger
  • Backhaus, Jochen
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    Abstract

    The paper is concerned with the hedging of credit derivatives, in particular synthetic CDO tranches, in a dynamic portfolio credit risk model with spread risk and default contagion. The model is constructed and studied via Markov-chain techniques. We discuss the immunization of a CDO tranche against spread- and event risk in the Markov-chain model and compare the results with market-standard hedge ratios obtained in a Gauss copula model. In the main part of the paper we derive model-based dynamic hedging strategies and study their properties in numerical experiments.

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    File URL: http://www.sciencedirect.com/science/article/B6V85-4XJ17KT-1/2/0526928ef1ceabd8691fdc2c6830c7af
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

    Volume (Year): 34 (2010)
    Issue (Month): 4 (April)
    Pages: 710-724
    Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
    Handle: RePEc:eee:dyncon:v:34:y:2010:i:4:p:710-724

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    Web page: http://www.elsevier.com/locate/jedc

    For corrections or technical questions regarding this item, or to correct its listing, contact: (Jeroen Loos).

    Related research

    Keywords: Dynamic hedging Portfolio credit risk Credit derivatives Incomplete markets Default contagion;

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    Cited by:
    1. Rüdiger Frey & Thorsten Schmidt, 2012. "Pricing and hedging of credit derivatives via the innovations approach to nonlinear filtering," Finance and Stochastics, Springer, vol. 16(1), pages 105-133, January.

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