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Credit risk tools, (numerical methods for finance, university of Limerick 2011)

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  • Esposito, Francesco Paolo

Abstract

In this work, we solve a risk measurement problem, which involves both credit and market risk. Specifically, We deal with the problem of pricing a synthetic CDO tranche and with the assessment of the evolution behavior of value of the net income resulting from the exposure to a single credit derivative of this sort. We cope with the pricing problem by constructing algorithms capable of computing the key variables. The second problem is solved via Monte Carlo simulation. The calculations, which constitute the main input of the simulation engine, can be easily implemented since they only result in the operations of matrix inversion and numerical integration. The flexibility of the risk evaluation method, which has been achieved through stochastic simulation, allows the system to be easily escalated and extended to a collection of basket credit derivatives.

Suggested Citation

  • Esposito, Francesco Paolo, 2011. "Credit risk tools, (numerical methods for finance, university of Limerick 2011)," MPRA Paper 40081, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:40081
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    References listed on IDEAS

    as
    1. David Durand, 1942. "Basic Yields of Corporate Bonds, 1900-1942," NBER Chapters, in: Basic Yields of Corporate Bonds, 1900-1942, pages 1-40, National Bureau of Economic Research, Inc.
    2. David Durand, 1942. "Basic Yields of Corporate Bonds, 1900-1942," NBER Books, National Bureau of Economic Research, Inc, number dura42-1.
    3. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-489, October.
    4. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," The Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    5. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    CDS; CDO; default correlation; hazard rates; PD; LGD; Exposure at Default; Potential Future Exosure;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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