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Hedging structured credit products during the credit crisis: A horse race of 10 models


  • Ascheberg, Marius
  • Bick, Björn
  • Kraft, Holger


Pricing and hedging structured credit products poses major challenges to financial institutions. This paper puts several valuation approaches through a crucial test: How did these models perform in one of the worst periods of economic history, September 2008, when Lehman Brothers went under? Did they produce reasonable hedging strategies? We study several bottom-up and top-down credit portfolio models and compute the resulting delta hedging strategies using either index contracts or a portfolio of single-name CDS contracts as hedging instruments. We compute the profit-and-loss profiles and assess the performances of these hedging strategies. Among all 10 pricing models that we consider the Student-t copula model performs best. The dynamical generalized-Poisson loss model is the best top-down model, but this model class has in general problems to hedge equity tranches. Our major finding is however that single-name and index CDS contracts are not appropriate instruments to hedge CDO tranches.

Suggested Citation

  • Ascheberg, Marius & Bick, Björn & Kraft, Holger, 2013. "Hedging structured credit products during the credit crisis: A horse race of 10 models," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1687-1705.
  • Handle: RePEc:eee:jbfina:v:37:y:2013:i:5:p:1687-1705
    DOI: 10.1016/j.jbankfin.2013.01.002

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    References listed on IDEAS

    1. Lutz Schloegl & Dominic O’Kane, 2005. "A note on the large homogeneous portfolio approximation with the Student-t copula," Finance and Stochastics, Springer, vol. 9(4), pages 577-584, October.
    2. Rama Cont & Yu Hang Kan, 2011. "Dynamic hedging of portfolio credit derivatives," Post-Print hal-00578008, HAL.
    3. Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. " Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-2049, December.
    4. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    5. Igor Halperin & Pascal Tomecek, 2009. "Climbing Down from the Top: Single Name Dynamics in Credit Top Down Models," Papers 0901.3404,
    6. Viktoriya Masol & Wim Schoutens, 2011. "Comparing alternative Levy base correlation models for pricing and hedging CDO tranches," Quantitative Finance, Taylor & Francis Journals, vol. 11(5), pages 763-773.
    7. Stephan Höcht & Rudi Zagst, 2010. "Pricing distressed CDOs with stochastic recovery," Review of Derivatives Research, Springer, vol. 13(3), pages 219-244, October.
    8. Francis A. Longstaff & Arvind Rajan, 2008. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," Journal of Finance, American Finance Association, vol. 63(2), pages 529-563, April.
    9. Instefjord, Norvald, 2005. "Risk and hedging: Do credit derivatives increase bank risk?," Journal of Banking & Finance, Elsevier, vol. 29(2), pages 333-345, February.
    10. Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, vol. 34(1), pages 157-170, March.
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    Cited by:

    1. Christian Koziol & Philipp Koziol & Thomas Schön, 2015. "Do correlated defaults matter for CDS premia? An empirical analysis," Review of Derivatives Research, Springer, vol. 18(3), pages 191-224, October.

    More about this item


    Structured products; P&L analysis; Hedging; Bottom-up models; Top-down models; Copulas; Self-exciting models;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation


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