Dynamic Conditioning and Credit Correlation Baskets
AbstractDynamic conditioning is a technique that allows one to formulate correlation models for large baskets without incurring in the curse of dimensionality. The individual price processes for each reference name can be described by a lattice model specified semi-parametrically or even nonparametrically and which can realistically have about 1000 sites. The time discretization step is chosen so small to satisfy the Courant stability condition and is typically of about a few hours. This constraint ensures needed smoothness for the single name probability kernels which can thus be directly manipulated. A flexible multi-factor correlation model can be obtained by means of conditioning trees corresponding to binomial processes with jumps. There is one conditioning tree associated to each reference names, one associated to each industry sector and a global one to the basket itself. Since the conditioning trees are correlated, the underlying processes are also mutually correlated. In this paper, we discuss a modeling framework for CDOs based on dynamic conditioning in greater detail than previously done in our other papers. We also show that the model calibrates well to index tranches throughout in the period from 2005 to the Spring of 2008 and yields instructive insights.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 8368.
Date of creation: 25 Jan 2008
Date of revision: 21 Apr 2008
CDO; pricing; dynamic conditioning; correlation modeling; semi-parametric; operator methods;
Find related papers by JEL classification:
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-04-29 (All new papers)
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.:
- Albanese, Claudio & Chen, Oliver X., 2006. "Implied migration rates from credit barrier models," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 607-626, February.
- Claudio Albanese & Adel Osseiran, 2007.
"Moment Methods for Exotic Volatility Derivatives,"
- Lucas, Andre & Klaassen, Pieter & Spreij, Peter & Straetmans, Stefan, 2001.
"An analytic approach to credit risk of large corporate bond and loan portfolios,"
Journal of Banking & Finance,
Elsevier, vol. 25(9), pages 1635-1664, September.
- Lucas, Andr‚ & Klaassen, Pieter & Spreij, Peter, 1999. "An analytic approach to credit risk of large corporate bond and loan portfolios," Serie Research Memoranda 0018, VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics.
- Albanese, Claudio, 2006. "Operator Methods, Abelian Processes And Dynamic Conditioning," MPRA Paper 5246, University Library of Munich, Germany, revised 06 Nov 2007.
- Albanese, Claudio & Vidler, Alicia, 2007. "A STRUCTURAL MODEL FOR CREDIT-EQUITY DERIVATIVES AND BESPOKE CDOs," MPRA Paper 5227, University Library of Munich, Germany, revised 09 Sep 2007.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).
If references are entirely missing, you can add them using this form.