Pricing and Hedging of CDOs: A Top Down Approach

22 Pages Posted: 14 Sep 2009 Last revised: 6 Dec 2009

See all articles by Damir Filipović

Damir Filipović

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Thorsten Schmidt

University of Freiburg

Date Written: December 4, 2009

Abstract

This paper considers the pricing and hedging of collateralized debt obligations (CDOs). CDOs are complex derivatives on a pool of credits which we choose to analyse in the top down model proposed in Filipovic et al. (2009). We reflect on the implied forward rates and bring them in connection with the top-down framework in Lipton and Shelton (2009) and Schonbucher (2005). Moreover, we derive variance-minimizing hedging strategies for hedgeing single tranches with the full index. The hedging strategies are given for the general case. We compute them also explicitly for a parsimonious one-factor affine model.

Keywords: collateralized debt obligations, single tranche CDO, variance-minimizing hedging

JEL Classification: G13, C60

Suggested Citation

Filipovic, Damir and Schmidt, Thorsten, Pricing and Hedging of CDOs: A Top Down Approach (December 4, 2009). Available at SSRN: https://ssrn.com/abstract=1472942 or http://dx.doi.org/10.2139/ssrn.1472942

Damir Filipovic (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Odyssea
Station 5
Lausanne, 1015
Switzerland

HOME PAGE: http://people.epfl.ch/damir.filipovic

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Thorsten Schmidt

University of Freiburg ( email )

Fahnenbergplatz
Freiburg, D-79085
Germany

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