Discrete tenor models for credit risky portfolios driven by time-inhomogeneous L\'evy processes

Ernst Eberlein, Zorana Grbac and Thorsten Schmidt

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Abstract: The goal of this paper is to specify dynamic term structure models with discrete tenor structure for credit portfolios in a top-down setting driven by time-inhomogeneous L\'evy processes. We provide a new framework, conditions for absence of arbitrage, explicit examples, an affine setup which includes contagion and pricing formulas for STCDOs and options on STCDOs. A calibration to iTraxx data with an extended Kalman filter shows an excellent fit over the full observation period. The calibration is done on a set of CDO tranche spreads ranging across six tranches and three maturities.

Date: 2010-06, Revised 2013-04
New Economics Papers: this item is included in nep-ifn
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