Affine Pricing and Hedging of Collateralized Debt Obligations

Zehra Eksi and Damir Filipovi\'c

Papers from arXiv.org

Abstract: This study deals with the pricing and hedging of single-tranche collateralized debt obligations (STCDOs). We specify an affine two-factor model in which a catastrophic risk component is incorporated. Apart from being analytically tractable, this model has the feature that it captures the dynamics of super-senior tranches, thanks to the catastrophic component. We estimate the factor model based on the iTraxx Europe data with six tranches and four different maturities, using a quasi-maximum likelihood (QML) approach in conjunction with the Kalman filter. We derive the model-based variance-minimizing strategy for the hedging of STCDOs with a dynamically rebalanced portfolio on the underlying swap index. We analyze the actual performance of the variance-minimizing hedge on the iTraxx Europe data. In order to assess the hedging performance further, we run a simulation analysis where normal and extreme loss scenarios are generated via the method of importance sampling. Both in-sample hedging and simulation analysis suggest that the variance-minimizing strategy is most effective for mezzanine tranches in terms of yielding less riskier hedging portfolios and it fails to provide adequate hedge performance regarding equity tranches.

Date: 2020-11
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/2011.10101 Latest version (application/pdf)

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:arx:papers:2011.10101

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().