Valuation of collateralized debt obligations with hierarchical Archimedean copulae

Barbara Choros-Tomczyk, Wolfgang Härdle and Ostap Okhrin

Journal of Empirical Finance, 2013, vol. 24, issue C, 42-62

Abstract: Modelling portfolio credit risk is one of the crucial challenges faced by financial services industry in the last few years. We propose the valuation model of collateralized debt obligations (CDO) based on hierarchical Archimedean copulae (HAC) with up to three parameters, with default intensities calibrated to market data and with random loss given defaults that are correlated with default times. The methods presented are used to reproduce the spreads of the iTraxx Europe tranches. Our approach describes the market prices better than the standard pricing procedure based on the Gaussian distribution. We also obtain a flat correlation smile across tranches thereby solving the implied correlation puzzle.

Keywords: CDO; Multivariate distributions; Copulae; Correlation smile; Loss given default (search for similar items in EconPapers)
JEL-codes: C13 G12 G13 G21 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:24:y:2013:i:c:p:42-62

DOI: 10.1016/j.jempfin.2013.08.001

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