Publication: Pricing tranched credit products with generalized multifactor models
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2007-05
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Abstract
The market for tranched credit products (CDOs, Itraxx tranches) is one of the fastest growing
segments in the credit derivatives industry. However, some assumptions underlying the standard
Gaussian onefactor
pricing model (homogeneity, single factor, Normality), which is the pricing
standard widely used in the industry, are probably too restrictive. In this paper we generalize the
standard model by means of a two by two model (two factors and two asset classes). We assume
two driving factors (business cycle and industry) with independent tStudent
distributions,
respectively, and we allow the model to distinguish among portfolio assets classes. In order to
illustrate the estimation of the parameters of the model, an empirical application with Moody's
data is also included.
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Collateral debt obligations, Factor models, Probit-Logit models