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On Models of Stochastic Recovery for Base Correlation

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  • Li, Hui
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    Abstract

    This paper discusses various ways to add correlated stochastic recovery to the base correlation framework for pricing CDOs. Several recent models are extended to more general framework. The pros and cons of these models for calibration to single name CDS and index CDO tranches are discussed. It is shown that negative forward recovery rate under fixed systematic factor appears in these models. This suggests that current static copula models of correlated default and recovery processes are inherently inconsistent.

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    File URL: http://mpra.ub.uni-muenchen.de/15750/
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    File URL: http://mpra.ub.uni-muenchen.de/16272/
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    File URL: http://mpra.ub.uni-muenchen.de/17894/
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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 15750.

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    Date of creation: Jun 2009
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    Handle: RePEc:pra:mprapa:15750

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    Related research

    Keywords: CDO; Gaussian Copula; Base Correlation; Stochastic Recovery; Correlated Loss Given Default;

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    Cited by:
    1. Li, Hui, 2009. "Double Impact on CVA for CDS: Wrong-Way Risk with Stochastic Recovery," MPRA Paper 19684, University Library of Munich, Germany.
    2. Li, Hui, 2010. "Downturn LGD: A Spot Recovery Approach," MPRA Paper 20010, University Library of Munich, Germany.
    3. Li, Hui, 2009. "Extension of Spot Recovery Model for Gaussian Copula," MPRA Paper 17944, University Library of Munich, Germany.

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