Title

An Empirical Study of Pricing and Hedging Collateralized Debt Obligation

Publication Type

Book Chapter

Publication Date

2007

Abstract

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

Keywords

Collateral debt obligation (CDO) pricing, Monte Carlo, Default correlation, Copula

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Advances in Econometrics

Volume

22

ISBN

9781848551961

Identifier

10.1016/S0731-9053(08)22002-5

Publisher

JAI Press

City or Country

Greenwich, CN