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On Default Correlation And Pricing Of Collateralized Debt Obligation By Copula Functions


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    (Department of Finance, Beihang University, Beijing 100083, China)


    (Department of Finance, Beihang University, Beijing 100083, China)


    (Department of Computer Science, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong, China)


    (School of Economics and Finance, Victoria University of Wellington, Wellington, New Zealand)


Default correlation is the key point for the pricing of multi-name credit derivatives. In this paper, we apply copulas to characterize the dependence structure of defaults, determine the joint default distribution, and give the price for a specific kind of multi-name credit derivative — collateralized debt obligation (CDO). We also analyze two important factors influencing the pricing of multi-name credit derivatives, recovery rates and copula function. Finally, we apply Clayton copula, in a numerical example, to simulate default times taking specific underlying recovery rates and average recovery rates, then price the tranches of a given CDO and then analyze the results.

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Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Information Technology and Decision Making.

Volume (Year): 05 (2006)
Issue (Month): 03 ()
Pages: 483-493

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Handle: RePEc:wsi:ijitdm:v:05:y:2006:i:03:p:483-493

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Keywords: Collateralized debt obligation (CDO); default correlation; copula; recovery rate; multi-name credit derivatives;


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Cited by:
  1. Philip Messow, 2012. "Pricing Synthetic CDOs Using a Three Regime Random-Factor-Loading Model," Ruhr Economic Papers 0317, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.


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