Basket default swaps, CDOs and factor copulas

Jean-Paul Laurent and Jon Gregory

Journal of Risk

Abstract: ABSTRACT We consider a factor approach to the pricing of basket credit derivatives and synthetic collateralized debt obligation (CDO) tranches. Our purpose is to deal in a convenient way with dependent defaults for a large number of names. We provide semi-explicit pricing formulae for basket default swaps and CDO tranches. Two cases are studied in detail: mean-variance mixture models and frailty models. We also compare prices under Gaussian and Clayton copulas.

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