Hedging default risks of CDOs in Markovian contagion models

J.-P. Laurent, A. Cousin and J.-D. Fermanian

Quantitative Finance, 2011, vol. 11, issue 12, 1773-1791

Abstract: We describe a replicating strategy of CDO tranches based upon dynamic trading of the corresponding credit default swap index. The aggregate loss follows a homogeneous Markov chain associated with contagion effects. Default intensities depend upon the number of defaults and are calibrated onto an input loss surface. Numerical implementation can be carried out thanks to a recombining tree. We examine how input loss distributions drive the credit deltas. We find that the deltas of the equity tranche are lower than those computed in the standard base correlation framework. This is related to the dynamics of dependence between defaults.

Date: 2011
References: Add references at CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://hdl.handle.net/10.1080/14697680903390126 (text/html)
Access to full text is restricted to subscribers.

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:taf:quantf:v:11:y:2011:i:12:p:1773-1791

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RQUF20

DOI: 10.1080/14697680903390126

Access Statistics for this article

Quantitative Finance is currently edited by Michael Dempster and Jim Gatheral

More articles in Quantitative Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().