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Pricing And Hedging Of Portfolio Credit Derivatives With Interacting Default Intensities

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  • RÜDIGER FREY

    ()
    (Department of Mathematics, University of Leipzig, 04009 Leipzig, Germany)

  • JOCHEN BACKHAUS

    ()
    (Department of Mathematics, University of Leipzig, 04009 Leipzig, Germany)

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    Abstract

    We consider reduced-form models for portfolio credit risk with interacting default intensities. In this class of models default intensities are modeled as functions of time and of the default state of the entire portfolio, so that phenomena such as default contagion or counterparty risk can be modeled explicitly. In the present paper this class of models is analyzed by Markov process techniques. We study in detail the pricing and the hedging of portfolio-related credit derivatives such as basket default swaps and collaterized debt obligations (CDOs) and discuss the calibration to market data.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 11 (2008)
    Issue (Month): 06 ()
    Pages: 611-634

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    Handle: RePEc:wsi:ijtafx:v:11:y:2008:i:06:p:611-634

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    Related research

    Keywords: Credit derivatives; CDOs; hedging; Markov chains;

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    Cited by:
    1. Henri Pages & Dylan Possamaï, 2014. "A mathematical treatment of bank monitoring incentives," Finance and Stochastics, Springer, vol. 18(1), pages 39-73, January.
    2. Pagès, H., 2012. "Bank monitoring incentives and optimal ABS," Working papers 377, Banque de France.
    3. Herbertsson, Alexander & Jang, Jiwook & Schmidt, Thorsten, 2009. "Pricing basket default swaps in a tractable shot-noise model," Working Papers in Economics 359, University of Gothenburg, Department of Economics.
    4. Didier Rulli\`ere & Diana Dorobantu & Areski Cousin, 2009. "An extension of Davis and Lo's contagion model," Science & Finance (CFM) working paper archive 0904.1653, Science & Finance, Capital Fund Management, revised Feb 2010.
    5. Takada, Hideyuki & Sumita, Ushio, 2011. "Credit risk model with contagious default dependencies affected by macro-economic condition," European Journal of Operational Research, Elsevier, vol. 214(2), pages 365-379, October.
    6. Jean-David Fermanian & Olivier Vigneron, 2012. "On break-even correlation: the way to price structured credit derivatives by replication," Science & Finance (CFM) working paper archive 1204.2251, Science & Finance, Capital Fund Management.
    7. Frey, Rüdiger & Backhaus, Jochen, 2010. "Dynamic hedging of synthetic CDO tranches with spread risk and default contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 710-724, April.
    8. Sebastian Heise & Reimer Kuehn, 2012. "Derivatives and Credit Contagion in Interconnected Networks," Science & Finance (CFM) working paper archive 1202.3025, Science & Finance, Capital Fund Management.
    9. Emilio Barucci & Marco Tolotti, 2009. "The dynamics of social interaction with agents’ heterogeneity," Working Papers 189, Department of Applied Mathematics, Università Ca' Foscari Venezia.
    10. Areski Cousin & Stéphane Crépey & Yu Kan, 2012. "Delta-hedging correlation risk?," Review of Derivatives Research, Springer, vol. 15(1), pages 25-56, April.

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