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Correlation Smile Matching for CDO Tranches with α Stable Distributions and Fitted Archimedan Copulas
[journal article]
Abstract As an extension of the standard Gaussian copula model to price CDO tranche swaps we present a generalization of a one-factor copula model based on stable distributions. For special parameter values these distributions coincide with Gaussian or Cauchy distributions, but changing the parameters allows... view more
As an extension of the standard Gaussian copula model to price CDO tranche swaps we present a generalization of a one-factor copula model based on stable distributions. For special parameter values these distributions coincide with Gaussian or Cauchy distributions, but changing the parameters allows a continuous deformation away from the Gaussian copula. All these factor copulas are embedded into a framework of stochastic correlations.
We furthermore generalize the linear dependency in the usual factor approach to a
more general Archimedean copula dependency between the individual trigger variable and the common latent factor.
Our analysis is carried out on a non-homogeneous correlation structure of the underlying portfolio. CDO tranche market premia, even through the correlation crisis in May 2005, can be reproduced by certain models. From a numerical perspective all these models are simple since calculations can be reduced to one dimensional numerical integrals.... view less
Classification
Economic Statistics, Econometrics, Business Informatics
Basic Research, General Concepts and History of Economics
Method
theory application
Free Keywords
Copulas; Correlation modelling; Credit derivatives; Credit models
Document language
English
Publication Year
2009
Page/Pages
p. 439-449
Journal
Quantitative Finance, 9 (2009) 4
DOI
https://doi.org/10.1080/14697680802464428
Status
Postprint; peer reviewed
Licence
PEER Licence Agreement (applicable only to documents from PEER project)