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On Default Correlation And Pricing Of Collateralized Debt Obligation By Copula Functions

  • PING LI

    (Department of Finance, Beihang University, Beijing 100083, China)

  • HOUSHENG CHEN

    (Department of Finance, Beihang University, Beijing 100083, China)

  • XIAOTIE DENG

    ()

    (Department of Computer Science, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong, China)

  • SHUNMING ZHANG

    (School of Economics and Finance, Victoria University of Wellington, Wellington, New Zealand)

Default correlation is the key point for the pricing of multi-name credit derivatives. In this paper, we apply copulas to characterize the dependence structure of defaults, determine the joint default distribution, and give the price for a specific kind of multi-name credit derivative — collateralized debt obligation (CDO). We also analyze two important factors influencing the pricing of multi-name credit derivatives, recovery rates and copula function. Finally, we apply Clayton copula, in a numerical example, to simulate default times taking specific underlying recovery rates and average recovery rates, then price the tranches of a given CDO and then analyze the results.

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Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Information Technology and Decision Making.

Volume (Year): 05 (2006)
Issue (Month): 03 ()
Pages: 483-493

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Handle: RePEc:wsi:ijitdm:v:05:y:2006:i:03:p:483-493
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