Pricing Synthetic CDO Tranches in a Model with Default Contagion Using the Matrix-Analytic Approach
We value synthetic CDO tranche spreads, index CDS spreads, kth-to-default swap spreads and tranchelets in an intensity-based credit risk model with default contagion. The default dependence is modelled by letting individual intensities jump when other defaults occur. The model is reinterpreted as a Markov jump process. This allow us to use a matrix-analytic approach to derive computationally tractable closed-form expressions for the credit derivatives that we want to study. Special attention is given to homogenous portfolios. For a fixed maturity of five years, such a portfolio is calibrated against CDO tranche spreads, index CDS spread and the average CDS and FtD spreads, all taken from the iTraxx Europe series. After the calibration, which render perfect fits, we compute spreads for tranchelets and kth-to-default swap spreads for different subportfolios of the main portfolio. We also investigate implied tranche-losses and the implied loss distribution in the calibrated portfolios.
|Date of creation:||31 Oct 2007|
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- Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December.
- Robert A. Jarrow, 2001. "Counterparty Risk and the Pricing of Defaultable Securities," Journal of Finance, American Finance Association, vol. 56(5), pages 1765-1799, October.
- Giesecke, Kay & Weber, Stefan, 2006. "Credit contagion and aggregate losses," Journal of Economic Dynamics and Control, Elsevier, vol. 30(5), pages 741-767, May.
- P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, 09.
- Stefan Weber & Kay Giesecke, 2003. "Credit Contagion and Aggregate Losses," Computing in Economics and Finance 2003 246, Society for Computational Economics.
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