Pricing Synthetic CDO Tranches in a Model with Default Contagion Using the Matrix-Analytic Approach
AbstractWe value synthetic CDO tranche spreads, index CDS spreads, kth-to-default swap spreads and tranchelets in an intensity-based credit risk model with default contagion. The default dependence is modelled by letting individual intensities jump when other defaults occur. The model is reinterpreted as a Markov jump process. This allow us to use a matrix-analytic approach to derive computationally tractable closed-form expressions for the credit derivatives that we want to study. Special attention is given to homogenous portfolios. For a fixed maturity of five years, such a portfolio is calibrated against CDO tranche spreads, index CDS spread and the average CDS and FtD spreads, all taken from the iTraxx Europe series. After the calibration, which render perfect fits, we compute spreads for tranchelets and kth-to-default swap spreads for different subportfolios of the main portfolio. We also investigate implied tranche-losses and the implied loss distribution in the calibrated portfolios.
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Bibliographic InfoPaper provided by University of Gothenburg, Department of Economics in its series Working Papers in Economics with number 270.
Length: 28 pages
Date of creation: 31 Oct 2007
Date of revision:
Contact details of provider:
Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden
Phone: 031-773 10 00
Web page: http://www.handels.gu.se/econ/
More information through EDIRC
Credit risk; intensity-based models; CDO tranches; index CDS; kth-to-default swaps; dependence modelling; default contagion; Markov jump processes; Matrix-analytic methods;
Find related papers by JEL classification:
- C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-11-10 (All new papers)
- NEP-BAN-2007-11-10 (Banking)
- NEP-RMG-2007-11-10 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
- P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, 09.
- Giesecke, Kay & Weber, Stefan, 2006. "Credit contagion and aggregate losses," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 741-767, May.
- Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December.
- Didier Rullière & Diana Dorobantu & Areski Cousin, 2013.
"An extension of Davis and Lo's contagion model,"
- repec:hal:wpaper:hal-00374367 is not listed on IDEAS
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