Hedging structured credit products during the credit crisis: A horse race of 10 models
AbstractPricing and hedging structured credit products poses major challenges to financial institutions. This paper puts several valuation approaches through a crucial test: How did these models perform in one of the worst periods of economic history, September 2008, when Lehman Brothers went under? Did they produce reasonable hedging strategies? We study several bottom-up and top-down credit portfolio models and compute the resulting delta hedging strategies using either index contracts or a portfolio of single-name CDS contracts as hedging instruments. We compute the profit-and-loss profiles and assess the performances of these hedging strategies. Among all 10 pricing models that we consider the Student-t copula model performs best. The dynamical generalized-Poisson loss model is the best top-down model, but this model class has in general problems to hedge equity tranches. Our major finding is however that single-name and index CDS contracts are not appropriate instruments to hedge CDO tranches.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Banking & Finance.
Volume (Year): 37 (2013)
Issue (Month): 5 ()
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Web page: http://www.elsevier.com/locate/jbf
Structured products; P&L analysis; Hedging; Bottom-up models; Top-down models; Copulas; Self-exciting models;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
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