Pricing of credit default index swap tranches with one-factor heavy-tailed copula models

Dezhong Wang, Svetlozar T. Rachev and Frank J. Fabozzi

Journal of Empirical Finance, 2009, vol. 16, issue 2, pages 201-215

Abstract: In this paper, we provide two one-factor heavy-tailed copula models for pricing a collateralized debt obligation and credit default index swap tranches: (1) a one-factor double t distribution with fractional degrees of freedom copula model and (2) a one-factor double mixture distribution of t and Gaussian distribution copula model. A time-varying tail-fatness parameter is introduced in each model, allowing one to change the tail-fatness of the copula function continuously. Fitting our model to comprehensive market data, we find that a model with fixed tail-fatness cannot fit market data well over time. The two models that we propose are capable of fitting market data well over time when using a proper time-varying tail-fatness parameter. Moreover, we find that the time-varying tail-fatness parameters change dramatically over a one-year period.

Keywords: Collateralized; Debt; Obligation; Credit; Default; Swap; Credit; Default; Index; Swap; Credit; Default; Index; Swap; Tranches (search for similar items in EconPapers)
Date: 2009

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Persistent link: http://EconPapers.repec.org/RePEc:eee:empfin:v:16:y:2009:i:2:p:201-215

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