Comparing alternative Levy base correlation models for pricing and hedging CDO tranches

Viktoriya Masol and Wim Schoutens

Quantitative Finance, 2011, vol. 11, issue 5, 763-773

Abstract: In this paper we investigate alternative Levy base correlation models that arise from the Gamma, Inverse Gaussian and CMY distribution classes. We compare these models with the basic (exponential) Levy base correlation model and the classical Gaussian base correlation model. For all investigated models, the Levy base correlation curve is significantly flatter than the corresponding Gaussian curve, which indicates better correspondence of the Levy models with reality. Furthermore, we present the results of pricing bespoke tranchlets and comparing deltas of both standard and custom-made tranches under all the considered models. We focus on deltas with respect to the CDS index and individual CDSs, and the hedge ratio for hedging the equity tranche with the junior mezzanine.

Keywords: Credit derivatives; Credit models; Correlation modelling; Levy process; Derivatives hedging (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (3)

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DOI: 10.1080/14697688.2010.535840

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