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|
|Contact details of provider:|| Postal: Department of Economics, School of Business, Economics and Law, University of Gothenburg, Box 640, SE 405 30 GÖTEBORG, Sweden|
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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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World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515
World Scientific Publishing Co. Pte. Ltd..
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