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Regime-Switching Extension of the NIG Factor Copula Model

In: Pricing and Risk Management of Synthetic CDOs

Author

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  • Anna Schlösser

    (Hedging and Derivatives Strategies)

Abstract

The large homogeneous cell extension of the NIG factor copula model was intro- duced and investigated in the previous chapter. With this extension the number of parameters is increased from two to six: ? and five correlation parameters for the rating classes AAA, AA, A, BBB and BB. Issuers with a rating lower than BB have not been observed in the iTraxx portfolios so far. Still we do not believe to be able to achieve a good fit of the complete history of the iTraxx prices with this model with the correlation parameters constant over time. During only the last 4 years when the iTraxx tranches were traded, different correlation regimes were observed. Very high correlations are observed during the current sup-prime crisis. The year before the crisis in July 2007 began, the correlation was in contrast very low. For this rea- son, an extension of the NIG factor copula model allowing for different correlation regimes is expected to better reflect the reality than the model with the constant correlation.

Suggested Citation

  • Anna Schlösser, 2011. "Regime-Switching Extension of the NIG Factor Copula Model," Lecture Notes in Economics and Mathematical Systems, in: Pricing and Risk Management of Synthetic CDOs, chapter 0, pages 185-226, Springer.
    • Handle: RePEc:spr:lnechp:978-3-642-15609-0_8
    DOI: 10.1007/978-3-642-15609-0_8
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