Estimating Tranche Spreads by Loss Process Simulation

10 Pages Posted: 16 Jul 2007

See all articles by Baeho Kim

Baeho Kim

Korea University Business School (KUBS)

Kay Giesecke

Stanford University - Management Science & Engineering

Date Written: July 15, 2007

Abstract

A credit derivative is a path dependent contingent claim on the aggregate loss in a portfolio of credit sensitive securities. We estimate the value of a credit derivative by Monte Carlo simulation of the affine point process that models the loss. We consider two algorithms that exploit the direct specification of the loss process in terms of an intensity. One algorithm is based on the simulation of intensity paths. Here discretization introduces bias into the results. The other algorithm facilitates exact simulation of default times and generates an unbiased estimator of the derivative price. We implement the algorithms to value index and tranche swaps, and we calibrate the loss process to quotes on the CDX North America High Yield index.

Keywords: point process, simulation, credit derivative

JEL Classification: C00, C13, C14, C51, C53, G12, G13, G33

Suggested Citation

Kim, Baeho and Giesecke, Kay, Estimating Tranche Spreads by Loss Process Simulation (July 15, 2007). Available at SSRN: https://ssrn.com/abstract=1000746 or http://dx.doi.org/10.2139/ssrn.1000746

Baeho Kim

Korea University Business School (KUBS) ( email )

Anam-dong, Sungbuk-Gu
Korea University Business School
Seoul, 136-701
82-2-3290-2626 (Phone)
82-2-922-7220 (Fax)

HOME PAGE: http://biz.korea.ac.kr/~baehokim

Kay Giesecke (Contact Author)

Stanford University - Management Science & Engineering ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States
(650) 723 9265 (Phone)
(650) 723 1614 (Fax)

HOME PAGE: http://www.stanford.edu/~giesecke/

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