On the Pricing of CDOs

CREDIT DERIVATIVES HANDBOOK, Chapter 11, P.U. Ali and G.N. Gregoriou, eds., pp. 229-258, McGraw-Hill

Posted: 4 Jul 2008

See all articles by Raquel M. Gaspar

Raquel M. Gaspar

ISEG and Cemapre/REM, Universidade de Lisboa

Thorsten Schmidt

University of Freiburg

Abstract

This chapter addresses the pricing of two popular portfolio credit derivatives: first-to-default swaps and collateralized debt obligations (CDOs). We use the recent model of Gaspar and Schmidt (2007) for the pricing of theses portfolio credit derivatives. This approach combines general quadratic models for term structures with shot-noise models and therefore naturally solves a number of important issues in credit portfolio risk. First, resulting pricing formulas are in closed form and therefore the model implementation is straightforward. Second, this class of models is able to incorporate well-known features of credit risky markets: realistic default correlations, default clustering and correlation between short-rate and credit spreads. Third, the recent turbulence in credit spreads caused by the U.S. subprime mortgage turmoil can be captured well.

Keywords: CDS, CDO, First-to-default Swaps, Quadratic Term Structures, Shot-noise

JEL Classification: C15,C12, G13, G33

Suggested Citation

Gaspar, Raquel M. and Schmidt, Thorsten, On the Pricing of CDOs. CREDIT DERIVATIVES HANDBOOK, Chapter 11, P.U. Ali and G.N. Gregoriou, eds., pp. 229-258, McGraw-Hill, Available at SSRN: https://ssrn.com/abstract=1155036

Raquel M. Gaspar (Contact Author)

ISEG and Cemapre/REM, Universidade de Lisboa ( email )

Rua Miguel Lupi, 20
room 510
Lisbon, 1249-078
Portugal

Thorsten Schmidt

University of Freiburg ( email )

Fahnenbergplatz
Freiburg, D-79085
Germany

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