On Dynamic Hedging of Single-Tranche Collateralized Debt Obligations

Zehra Eksi and Damir Filipović
Additional contact information
Zehra Eksi: Vienna University of Economics and Business, Institute for Statistics and Mathematics
Damir Filipović: Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

No 13-18, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This study deals with the dynamic hedging of single-tranche collateralized debt obligations (STCDOs). As a first step, we specify a top-down affine factor model in which a catastrophic risk component is incorporated in order to capture the dynamics of super-senior tranches. Next, we derive the model-based variance-minimizing strategy for the hedging of STCDOs with a dynamically rebalanced portfolio on the underlying index swap. We analyze the actual performance of the variance-minimizing and the model-free regression-based hedging on the iTraxx Europe data. Results of the in-sample hedging analysis indicate that the regression-based hedge outperforms the variance-minimizing hedge based on various criteria. In order to assess the two hedging strategies further, we run a simulation analysis where normal and extreme loss scenarios are generated via the method of importance sampling. Performing the hedging analysis on the set of simulated scenarios we find that, overall, the variance-minimizing strategy is more effective in terms of yielding less riskier hedging portfolios.

Keywords: single-tranche CDO; affine term-structure of credit spreads; catastrophic risk; variance-minimizing hedge; regression-based hedge (search for similar items in EconPapers)
JEL-codes: C51 G12 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2013-04
References: Add references at CitEc
Citations:

Downloads: (external link)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2248666 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1318

Access Statistics for this paper

More papers in Swiss Finance Institute Research Paper Series from Swiss Finance Institute Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().