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A Dynamic Correlation Modelling Framework with Consistent Stochastic Recovery

Author

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  • Li, Yadong

Abstract

This paper describes a flexible and tractable bottom-up dynamic correlation modelling framework with a consistent stochastic recovery specification. In this modelling framework, only the joint distributions of default indicators are determined from the calibration to the index tranches; and the joint distribution of default time and spread dynamics can be changed independently from the CDO tranche pricing by applying one of the existing top-down methods to the common factor process. Numerical results showed that the proposed modelling method achieved good calibration to the index tranches across multiple maturities under the current market conditions. This modelling framework offers a practical approach to price and risk manage the exotic correlation products.

Suggested Citation

  • Li, Yadong, 2009. "A Dynamic Correlation Modelling Framework with Consistent Stochastic Recovery," MPRA Paper 14919, University Library of Munich, Germany, revised 02 Apr 2009.
    • Handle: RePEc:pra:mprapa:14919
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    File URL: https://mpra.ub.uni-muenchen.de/14919/1/MPRA_paper_14919.pdf
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    File URL: https://mpra.ub.uni-muenchen.de/20457/2/MPRA_paper_20457.pdf
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    References listed on IDEAS

    as
    1. Unknown, 2005. "Forward," 2005 Conference: Slovenia in the EU - Challenges for Agriculture, Food Science and Rural Affairs, November 10-11, 2005, Moravske Toplice, Slovenia 183804, Slovenian Association of Agricultural Economists (DAES).
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    Cited by:

    1. Hui Li, 2013. "A Note On The Double Impact On Cva For Cds: Wrong-Way Risk With Stochastic Recovery," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(03), pages 1-14.
    2. Yadong Li & Ariye Shater, 2010. "Valuation Bound of Tranche Options," Papers 1004.1759, arXiv.org.
    3. Li, Hui, 2009. "Extension of Spot Recovery Model for Gaussian Copula," MPRA Paper 17944, University Library of Munich, Germany.
    4. Yadong Li, 2010. "Consistent Valuation of Bespoke CDO Tranches," Papers 1004.1758, arXiv.org.

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    More about this item

    Keywords

    Credit; Correlation; CDO; Dynamic; Copula; Stochastic Recovery; Bottom-up; Top-down;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

    NEP fields

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