Search results

This paper studies the pricing of collateralized debt obligation (CDO) using Monte Carlo and analytic methods. Both methods are developed within the framework of the reduced form model. One-factor Gaussian Copula is used for treating default correlations amongst the collateral portfolio. Based on the two methods, the portfolio loss, the expected loss in each CDO tranche, tranche spread, and the default delta sensitivity are analyzed with respect to different parameters such as maturity, default correlation, default intensity or hazard rate, and recovery rate. We provide a careful study of the effects of different parametric impact. Our results show that Monte Carlo method is slow and not robust in the calculation of default delta sensitivity. The analytic approach has comparative advantages for pricing CDO. We also employ empirical data to investigate the implied default correlation and base correlation of the CDO. The implication of extending the analytical approach to incorporating Levy processes is also discussed.

The main theme of this volume is credit risk and credit derivatives. Recent developments in financial markets show that appropriate modeling and quantification of credit risk is fundamental in the context of modern complex structured financial products. Moreover, there is a need for further developments in our understanding of this important area. In particular modeling defaults and their correlation has been a real challenge in recent years, and still is. This problem is even more relevant after the so-called subprime crisis that hit in the summer of 2007. This makes the volume very timely and hopefully useful for researchers in the area of credit risk and credit derivatives.