The pricing and hedging of synthetic CDOs under the conditional independence assumption

Publication Type

Journal Article

Publication Date

1-2009

Abstract

In this paper we investigate the valuation and hedging issues of synthetic collateral debt obligations (CDOs) under the conditional independence assumption. The probability bucketing method of Hull and White (2004) enables us to construct the loss distribution, and we characterize the correlation structure between defaults based on the factor-copula formalism initiated by Laurent and Gregory (2003) to arrive at a semi-analytic valuation framework. We consider risk measures that are adequate for assessing the relative risks of tranches. Efficient calculation of the hedging parameters is demonstrated, and we provide an in-depth analysis for the relevant hedging implications followed from our numerical results.

Keywords

¼šsynthetic CDOs, factor copulae, tranche Deltas, loss distributions

Discipline

Finance and Financial Management | Management Information Systems

Research Areas

Corporate Reporting and Disclosure

Publication

Journal of Financial Studies

Volume

17

Issue

1

First Page

1

Last Page

40

ISSN

1022-2898

Publisher

Taiwan Finance Association

Additional URL

http://www.jfs.org.tw/index.php/jfs/article/view/2011055

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