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CDO and HAC

Author

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  • Choroś, Barbara
  • Härdle, Wolfgang Karl
  • Okhrin, Ostap

Abstract

Modelling portfolio credit risk is one of the crucial challenges faced by financial services industry in the last few years. We propose the valuation model of collateralized debt obligations (CDO) based on copula functions with up to three parameters, with default intensities estimated from market data and with a random loss given default that is correlated with default times. The methods presented are used to reproduce the spreads of the iTraxx Europe tranches. We apply hierarchical Archimedean copulae (HAC) whose construction allows for the fact that the risky assets of the CDO pool are chosen from six different industry sectors. The dependence among the assets from the same group is specified with the higher value of the copula parameter, otherwise the lower value of the parameter is ascribed. The copula with two and three parameters models the relation between the loss given default and the default times. Our approach describes the market prices better than the standard pricing procedure based on the Gaussian distribution.

Suggested Citation

  • Choroś, Barbara & Härdle, Wolfgang Karl & Okhrin, Ostap, 2009. "CDO and HAC," SFB 649 Discussion Papers 2009-038, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    • Handle: RePEc:zbw:sfb649:sfb649dp2009-038
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    References listed on IDEAS

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    15. Cao, Ji & Härdle, Wolfgang Karl & Mungo, Julius, 2009. "A joint analysis of the KOSPI 200 option and ODAX option markets dynamics," SFB 649 Discussion Papers 2009-019, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    16. Xia, Yingcun & Härdle, Wolfgang Karl & Linton, Oliver, 2009. "Optimal smoothing for a computationally and statistically efficient single index estimator," SFB 649 Discussion Papers 2009-028, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    17. Ho, Joanne & Odening, Martin, 2009. "Weather-based estimation of wildfire risk," SFB 649 Discussion Papers 2009-032, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
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    19. Stephanie Kremer & Alexander Bick & Dieter Nautz, 2013. "Inflation and growth: new evidence from a dynamic panel threshold analysis," Empirical Economics, Springer, vol. 44(2), pages 861-878, April.
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    21. Hanewald, Katja, 2009. "Lee-Carter and the macroeconomy," SFB 649 Discussion Papers 2009-008, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    22. Belomestny, Denis, 2009. "Spectral estimation of the fractional order of a Lévy process," SFB 649 Discussion Papers 2009-021, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
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    25. Härdle, Wolfgang Karl & Okhrin, Ostap, 2009. "De copulis non est disputandum - Copulae: An overview," SFB 649 Discussion Papers 2009-031, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
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    Citations

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    as


    Cited by:

    1. Strausz, Roland, 2009. "The political economy of regulatory risk," SFB 649 Discussion Papers 2009-040, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    2. Barbara Choroś-Tomczyk & Wolfgang Karl H�rdle & Ludger Overbeck, 2014. "Copula dynamics in CDOs," Quantitative Finance, Taylor & Francis Journals, vol. 14(9), pages 1573-1585, September.
    3. Michał Grajek & Lars-Hendrik Röller, 2012. "Regulation and Investment in Network Industries: Evidence from European Telecoms," Journal of Law and Economics, University of Chicago Press, vol. 55(1), pages 189-216.
    4. repec:hum:wpaper:sfb649dp2009-040 is not listed on IDEAS
    5. Michał Grajek & Lars-Hendrik Röller, 2012. "Regulation and Investment in Network Industries: Evidence from European Telecoms," Journal of Law and Economics, University of Chicago Press, vol. 55(1), pages 189-216.
    6. repec:hum:wpaper:sfb649dp2009-041 is not listed on IDEAS
    7. Grith, Maria & Härdle, Wolfgang Karl & Park, Juhyun, 2009. "Shape invariant modelling pricing kernels and risk aversion," SFB 649 Discussion Papers 2009-041, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.

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    More about this item

    Keywords

    CDO; CDS; multivariate distributions; Copulae; correlation smile; loss given default;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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