Forward Equations for Portfolio Credit Derivatives
Imperial College London; CNRS - Universite de Paris VI
Ioana A. Savescu
Merrill Lynch & Co. - Merrill Lynch, UK
Columbia University Center for Financial Engineering, Financial Engineering Report No. 2008-05
We introduce an alternative approach for computing the values of CDO tranche spreads in reduced-form models for portfolio credit derivatives ("top-down" models), which allows for efficient computations and can be used as an ingredient of an efficient calibration algorithm. Our approach is based on the solution of a system of ordinary differential equations, which is the analogue for portfolio credit derivatives of Dupire's famous equation for call option prices. It allows to efficiently price CDOs and other portfolio credit derivatives without Monte Carlo simulation.
Number of Pages in PDF File: 22
Keywords: credit risk, portfolio credit derivatives, CDO, derivative pricing, tranche
JEL Classification: G13,C14, C63working papers series
Date posted: April 25, 2008
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