PRICING AND HEDGING OF CDO-SQUARED TRANCHES BY USING A ONE FACTOR LÉVY MODEL

Florence Guillaume (), Philippe Jacobs () and Wim Schoutens ()
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Florence Guillaume: Department of Mathematics, K. U. Leuven, Celestijnenlaan 200 B, B-3001 Leuven, Belgium
Philippe Jacobs: Value and Risk Management Department, KBC Group, Belgium
Wim Schoutens: Department of Mathematics, K. U. Leuven, Celestijnenlaan 200 B, B-3001 Leuven, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2009, vol. 12, issue 05, 663-685

Abstract: This paper provides a comparison of the exponential copula Lévy model with the classical Gaussian copula model for the pricing of CDO-squared tranches. Several approximations of the recursive approach are considered: a full Monte Carlo approximation, a multivariate Normal approximation of the joint inner CDO loss distribution and a multivariate Poisson approximation of the joint number of defaults affecting the inner CDOs. More particularly, a sensitivity analysis is carried out for three particular days characterized by a low, medium and high value of the quoted iTraxx and CDX index spreads. Moreover, this paper features a comparison of the exponential Lévy and Gaussian Deltas under the multivariate Normal approximation for a period extended from 20 September 2007 until 13 February 2008. The Deltas are computed with respect to a weighted and unweighted version of the CDS pool as well as with respect to another CDO-squared tranche.

Keywords: Credit risk; CDOs-squared; collateralized debt obligations; correlation; copula; hedging (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S0219024909005397

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