BSLP: Markovian bivariate spread-loss model for portfolio credit derivatives

Matthias Arnsdorf and Igor Halperin

Journal of Computational Finance

Abstract: ABSTRACT The bivariate spread-loss portfolio is a two-dimensional dynamic model of interacting portfolio-level loss and loss intensity processes. It is constructed as a Markovian, short-rate intensity model, which facilitates fast lattice methods for pricing various portfolio credit derivatives such as tranche options, forward-starting tranches, leveraged super-senior tranches etc. A semi-parametric model specification is used to achieve near perfect calibration to any set of consistent portfolio tranche quotes. The onedimensional local intensity model obtained in the zero volatility limit of the stochastic intensity is useful in its own right for pricing non-standard index tranches by arbitrage-free interpolation.

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