Pricing and Hedging of CDO-Squared Tranches by Using a One Factor Levy Model

International Journal of Theoretical and Applied Finance, Vol. 12, No. 5, pp. 663-685, 2009

Posted: 25 Apr 2010

See all articles by Florence Guillaume

Florence Guillaume

Independent

Wim Schoutens

KU Leuven - Department of Mathematics

Date Written: August 1, 2009

Abstract

This paper provides a comparison of the exponential copula Lévy model with the classical Gaussian copula model for the pricing of CDO-squared tranches. Several approximations of the recursive approach are considered: a full Monte Carlo approximation, a multivariate Normal approximation of the joint inner CDO loss distribution and a multivariate Poisson approximation of the joint number of defaults affecting the inner CDOs. More particularly, a sensitivity analysis is carried out for three particular days characterized by a low, medium and high value of the quoted iTraxx and CDX index spreads. Moreover, this paper features a comparison of the exponential Lévy and Gaussian Deltas under the multivariate Normal approximation for a period extended from 20 September 2007 until 13 February 2008. The Deltas are computed with respect to a weighted and unweighted version of the CDS pool as well as with respect to another CDO-squared tranche.

Keywords: Credit risk, CDOs-squared, collateralized debt obligations, correlation, copula, hedging

Suggested Citation

Guillaume, Florence and Schoutens, Wim, Pricing and Hedging of CDO-Squared Tranches by Using a One Factor Levy Model (August 1, 2009). International Journal of Theoretical and Applied Finance, Vol. 12, No. 5, pp. 663-685, 2009. Available at SSRN: https://ssrn.com/abstract=1515547

Florence Guillaume (Contact Author)

Independent ( email )

No Address Available
United States

Wim Schoutens

KU Leuven - Department of Mathematics ( email )

Celestijnenlaan 200 B
Leuven, B-3001
Belgium

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