On the Relative Pricing of Long Maturity S&P 500 Index Options and CDX Tranches
38 Pages Posted: 27 Jan 2010
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On the Relative Pricing of Long Maturity S&P 500 Index Options and CDX Tranches
On the Relative Pricing of Long Maturity S&P 500 Index Options and Cdx Tranches
Date Written: January 26, 2010
Abstract
We investigate a structural model of market and firm-level dynamics in order to jointly price long-dated S&P 500 options and tranche spreads on the five-year CDX index. We demonstrate the importance of calibrating the model to match the entire term structure of CDX index spreads because it contains pertinent information regarding the timing of expected defaults and the specification of idiosyncratic dynamics. Our model matches the time series of tranche spreads well, both before and during the financial crisis, thus offering a resolution to the puzzle reported by Coval, Jurek and Stafford (2009).
Keywords: CDX tranche spreads
JEL Classification: G13, G14
Suggested Citation: Suggested Citation
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