Copula Dynamics in CDOs
SFB 649 Discussion Paper 2012-032
25 Pages Posted: 7 Jan 2017
Date Written: January 9, 2012
Values of tranche spreads of collateralized debt obligations (CDOs) are driven by the joint default performance of the assets in the collateral pool. The dependence between the names in the portfolio mainly depends on current economic conditions. Therefore, a correlation implied from tranches can be seen as a measure of the general health of the credit market. We analyse the European market of standardized CDOs using tranches of iTraxx index in the periods before and during the global financial crisis. We investigate the evolution of the correlations using different copula models: the standard Gaussian, the NIG, the double-t, and the Gumbel copula model. After calibration of these models one obtains a time varying vector of parameters. We analyse the dynamic pattern of these coefficients. That enables us to forecast future parameters and consequently calculate Value-at-Risk measures for iTraxx Europe tranches.
Keywords: CDO, multivariate distributions, copula, implied correlations, Value-at- Risk
JEL Classification: C13, C22, C53, G32
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