Contagion models a la carte: which one to choose?

Harry Zheng

Quantitative Finance, 2013, vol. 13, issue 3, 399-405

Abstract: We propose a copula contagion mixture model for correlated default times. The model includes the well-known factor, copula, and contagion models as its special cases. The key advantage of such a model is that we can study the interaction of different models and their pricing impact. Specifically, we model the default times of the underlying names in a reference portfolio to follow contagion intensity processes with exponential decay coupled with a copula dependence structure. We also model the default time of the counterparty and its dependence structure with the reference portfolio. Numerical tests show that correlation and contagion have an enormous joint impact on the rates of CDO tranches and the corresponding credit value adjustments are extremely high to compensate for the wrong-way risk.

Date: 2013
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Citations: View citations in EconPapers (5)

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DOI: 10.1080/14697688.2012.708428

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