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A Spot Stochastic Recovery Extension of the Gaussian Copula

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  • Bennani, Norddine
  • Maetz, Jerome
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    Abstract

    The market evolution since the end of 2007 has been characterized by an increase of systemic risk and a high number of defaults. Realized recovery rates have been very dispersed and different from standard assumptions, while 60%-100% super-senior tranches on standard indices have started to trade with significant spread levels. This has triggered a growing interest for stochastic recovery modelling. This paper presents an extension to the standard Gaussian copula framework that introduces a consistent modelling of stochastic recovery. We choose to model directly the spot recovery, which allows to preserve time consistency, and compare this approach to the standard ones, defined in terms of recovery to maturity. Taking a specific form of the spot recovery function, we show that the model is flexible and tractable, and easy to calibrate to both individual credit spread curves and index tranche markets. Through practical numerical examples, we analyze specific model properties, focusing on default risk.

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    File URL: http://mpra.ub.uni-muenchen.de/19736/
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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 19736.

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    Date of creation: 01 Jul 2009
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    Handle: RePEc:pra:mprapa:19736

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    Related research

    Keywords: stochastic recovery; CDO; correlation smile; base correlation; copula; factor model; default risk;

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    Cited by:
    1. Choroś-Tomczyk, Barbara & Härdle, Wolfgang Karl & Okhrin, Ostap, 2013. "Valuation of collateralized debt obligations with hierarchical Archimedean copulae," Journal of Empirical Finance, Elsevier, vol. 24(C), pages 42-62.

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