Intensity Gamma: A New Approach to Pricing Portfolio Credit Derivatives

14 Pages Posted: 12 Jun 2006

See all articles by Mark S. Joshi

Mark S. Joshi

University of Melbourne - Centre for Actuarial Studies (deceased)

Alan M. Stacey

Lehman Brothers International, Europe

Date Written: May 16, 2006

Abstract

We develop a completely new model for correlation of credit defaults based on a financially intuitive concept of business time similar to that in the Variance Gamma model for stock price evolution. Solving a simple equation calibrates each name to its credit spread curve and we show that the overall model can be calibrated to the market base correlation curve of a tranched CDO index. Once this calibration is performed, obtaining consistent arbitrage-free prices for non-standard tranches, products based on different underlying names and even more exotic products such as CDO2 is straightforward and rapid.

Keywords: portffolio credit derivatives, gamma process, CDO

JEL Classification: C19

Suggested Citation

Joshi, Mark and Stacey, Alan M., Intensity Gamma: A New Approach to Pricing Portfolio Credit Derivatives (May 16, 2006). Available at SSRN: https://ssrn.com/abstract=907384 or http://dx.doi.org/10.2139/ssrn.907384

Mark Joshi (Contact Author)

University of Melbourne - Centre for Actuarial Studies (deceased) ( email )

Melbourne, 3010
Australia

Alan M. Stacey

Lehman Brothers International, Europe ( email )

25 Bank Street
30th Floor
London E14 5LE
United Kingdom

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