Hedging Structured Credit Products During the Credit Crisis: A Horse Race of 10 Models

59 Pages Posted: 8 Dec 2011 Last revised: 31 Dec 2012

See all articles by Marius Ascheberg

Marius Ascheberg

Goethe University Frankfurt

Björn Bick

Goethe University Frankfurt

Holger Kraft

Goethe University Frankfurt

Date Written: December 31, 2012

Abstract

Pricing and hedging structured credit products poses major challenges to financial institutions. This has become very clear during the recent credit crisis. This paper puts several valuation approaches through a crucial test: How did these models perform in one of the worst periods of economic history, September 2008, when Lehman Brothers went down? Did they produce reasonable hedging strategies? We study several bottom-up and top-down credit portfolio models and compute the resulting delta hedging strategies using either index contracts or a portfolio of single-name CDS contracts as hedging instruments. We compute the profit-and-loss profiles and assess the performances of these hedging strategies. Among all 10 pricing models that we consider the Student-t copula model performs the best. The dynamical generalized-Poisson loss model is the best top-down model, but this model class has in general problems to hedge equity tranches. Our major finding is however that single-name and index CDS contracts are not appropriate instruments to hedge CDO tranches.

Keywords: Structured products, P&L analysis, Hedging, Bottom-up models, Top-down models, Copulas, Self-exciting models

JEL Classification: G13, G33

Suggested Citation

Ascheberg, Marius and Bick, Björn and Kraft, Holger, Hedging Structured Credit Products During the Credit Crisis: A Horse Race of 10 Models (December 31, 2012). Available at SSRN: https://ssrn.com/abstract=1969157 or http://dx.doi.org/10.2139/ssrn.1969157

Marius Ascheberg

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Björn Bick (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Holger Kraft

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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