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Please use this identifier to cite or link to this item: http://hdl.handle.net/10400.5/2559

Title: CDOs in the Light of the Current Crisis
Authors: Gaspar, Raquel M.
Schmidt, Thorsten
Keywords: CDO
Shot-noise processes
affine models
Issue Date: Jun-2008
Publisher: ISEG - ADVANCE
Citation: Gaspar, Raquel M. e Thorsten Schmidt. 2008. "CDOs in the Light of the Current Crisis". Instituto Superior de Economia e Gestão – ADVANCE Working paper nº 2/2008
Series/Report no.: ADVANCE Working paper;nº 2/2008
Abstract: This paper proposes a top-down model for pricing Collateralized Debt Obligation (CDOs). Our proposal is both treatable and realistic, in the sense we are able to obtain closed-form solutions to single tranche CDOs and capturing extreme credit events. We use as key ingredients the so-called (T, x)-bonds, as proposed in Filipovic, Overbeck, and Schmidt (2008), but generalize their affine specificationby including shot-noise processes. Our claim is that affine diffusions combined with shot-noise processes lead to an improved modeling of CDO spreads in comparison to existing affine jump-diffusion models. The proposed approach allows in particular for better capturing the possibility of extreme events, like the ones underlying the current crisis. We illustrate our results with a very concrete (simple) instance of our class of models. Finally, we identify the connections between the top-down and bottom-up approaches for modeling credit risk, within our class of models. Concretely, we show that even when taking a bottom-up approach the aggregate loss process would be a process of affine shot-noise type.
URI: http://hdl.handle.net/10400.5/2559
Publisher version: http://pascal.iseg.utl.pt/~advance/200802.pdf
Appears in Collections:DG - Documentos de trabalho / Working Papers
ADVANCE Working Papers

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