A note on the correlation smile
AbstractThe correct modeling of default dependence is essential for the valuation of multiname credit derivatives. However for the pricing of synthetic CDOs a one-factor Gaussian copula model with constant and equal pairwise correlations, default intensities and recovery rates for all assets in the reference portfolio has become the standard market model. If this model were a reflection of market opinion there wouldn't be the implied correlation smile that is observed in the market. The purpose of this paper is to explain the structure of the smile by discussing the influence of different correlation matrices on CDO spreads. --
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Bibliographic InfoPaper provided by University of Tübingen, School of Business and Economics in its series Tübinger Diskussionsbeiträge with number 297.
Date of creation: 2005
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default risk; CDOs; implied correlation smile; correlation matrx; heterogeneity;
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- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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- Balakrishna, B S, 2006. "A Semi-Analytical Parametric Model for Dependent Defaults," MPRA Paper 14918, University Library of Munich, Germany, revised 15 May 2007.
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