Dynamic Hedging of Portfolio Credit Risk in a Markov Copula Model

Tomasz R. Bielecki, Areski Cousin, Stéphane Crépey () and Alexander Herbertsson
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Tomasz R. Bielecki: Illinois Institute of Technology
Areski Cousin: LSAF
Stéphane Crépey: Université d’Évry Val d’Essonne
Alexander Herbertsson: University of Gothenburg

Journal of Optimization Theory and Applications, 2014, vol. 161, issue 1, No 5, 90-102

Abstract: Abstract We devise a bottom-up dynamic model of portfolio credit risk where instantaneous contagion is represented by the possibility of simultaneous defaults. Due to a Markovian copula nature of the model, calibration of marginals and dependence parameters can be performed separately using a two-step procedure, much like in a standard static copula setup. In this sense this solves the bottom-up top-down puzzle which the CDO industry had been trying to do for a long time. This model can be used for any dynamic portfolio credit risk issue, such as dynamic hedging of CDOs by CDSs, or CVA computations on credit portfolios.

Keywords: Portfolio credit risk; Credit derivatives; Markov copula model; Common shocks; Dynamic hedging (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s10957-013-0318-4

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