Dynamic hedging of synthetic CDO tranches with spread risk and default contagion
The paper is concerned with the hedging of credit derivatives, in particular synthetic CDO tranches, in a dynamic portfolio credit risk model with spread risk and default contagion. The model is constructed and studied via Markov-chain techniques. We discuss the immunization of a CDO tranche against spread- and event risk in the Markov-chain model and compare the results with market-standard hedge ratios obtained in a Gauss copula model. In the main part of the paper we derive model-based dynamic hedging strategies and study their properties in numerical experiments.
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- Giesecke, Kay & Weber, Stefan, 2006. "Credit contagion and aggregate losses," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 741-767, May.
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- David Colwell & Nadima El-Hassan & Oh-Kang Kwon, 2004. "Hedging Diffusion Processes by Local Risk-Minimisation with Applications to Index Tracking," Research Paper Series 119, Quantitative Finance Research Centre, University of Technology, Sydney.
- Rüdiger Frey & Jochen Backhaus, 2008. "Pricing And Hedging Of Portfolio Credit Derivatives With Interacting Default Intensities," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(06), pages 611-634.
- M. Davis & V. Lo, 2001. "Infectious defaults," Quantitative Finance, Taylor & Francis Journals, vol. 1(4), pages 382-387.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics. Full references (including those not matched with items on IDEAS)
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