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

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

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 st...

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Bibliographic Details
Main Authors: CHIANG, Mi-Hsiu, YUEH, Meng-Lan, LIN, An-Ping
Format: text
Language:English
Published: Institutional Knowledge at Singapore Management University 2009
Subjects:
¼šsynthetic CDOs
factor copulae
tranche Deltas
loss distributions
Finance and Financial Management
Management Information Systems
Online Access:https://ink.library.smu.edu.sg/soa_research/1566
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Institution: Singapore Management University
Language: English
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Summary: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.

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