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Pricing And Hedging Of Cdo-Squared Tranches By Using A One Factor Lévy Model

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Author Info

  • FLORENCE GUILLAUME

    ()
    (Department of Mathematics, K. U. Leuven, Celestijnenlaan 200 B, B-3001 Leuven, Belgium)

  • PHILIPPE JACOBS

    ()
    (Value and Risk Management Department, KBC Group, Belgium)

  • WIM SCHOUTENS

    ()
    (Department of Mathematics, K. U. Leuven, Celestijnenlaan 200 B, B-3001 Leuven, Belgium)

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    Abstract

    This paper provides a comparison of the exponential copula Lévy model with the classical Gaussian copula model for the pricing of CDO-squared tranches. Several approximations of the recursive approach are considered: a full Monte Carlo approximation, a multivariate Normal approximation of the joint inner CDO loss distribution and a multivariate Poisson approximation of the joint number of defaults affecting the inner CDOs. More particularly, a sensitivity analysis is carried out for three particular days characterized by a low, medium and high value of the quoted iTraxx and CDX index spreads. Moreover, this paper features a comparison of the exponential Lévy and Gaussian Deltas under the multivariate Normal approximation for a period extended from 20 September 2007 until 13 February 2008. The Deltas are computed with respect to a weighted and unweighted version of the CDS pool as well as with respect to another CDO-squared tranche.

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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): 12 (2009)
    Issue (Month): 05 ()
    Pages: 663-685

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    Handle: RePEc:wsi:ijtafx:v:12:y:2009:i:05:p:663-685

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    Related research

    Keywords: Credit risk; CDOs-squared; collateralized debt obligations; correlation; copula; hedging;

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