Analytical Techniques for Synthetic CDOs and Credit Default Risk Measures
In this article, we present pricing and risk management of synthetic CDOs and risk management of credit portfolios are closely related problems as both require modeling of the same distribution of portfolio loss. The valuation of a single tranche CDO is equivalent in complexity to the calculation of credit default VaR for a portfolio of single name entities, while the valuation of CDO2 (CDO-squared) is a task closely related to the calculation of credit default VaR for a portfolio of single tranche CDOs. We examine the analytical techniques developed for credit portfolio problems with a view to CDO applications and find that the saddlepoint method works better than the alternatives, leading to a new, fast technique for CDO2 pricing and hedging.
Authors: Alexander Antonov, Serguei Mechkov, and Timur Misirpashaev
In this article, we present pricing and risk management of synthetic CDOs and risk management of credit portfolios are closely related problems as both require modeling of the same distribution of portfolio loss. The valuation of a single tranche CDO is equivalent in complexity to the calculation of credit default VaR for a portfolio of single name entities, while the valuation of CDO2 (CDO-squared) is a task closely related to the calculation of credit default VaR for a portfolio of single tranche CDOs. We examine the analytical techniques developed for credit portfolio problems with a view to CDO applications and find that the saddlepoint method works better than the alternatives, leading to a new, fast technique for CDO2 pricing and hedging.
Authors: Alexander Antonov, Serguei Mechkov, and Timur Misirpashaev
Authors
Dr. Alexandre Antonov
Dr. Antonov received his PhD degree from the Landau Institute for Theoretical Physics in 1997 and joined Numerix in 1998, where he currently works as a Senior Vice President of Quantitative Research. His activity is concentrated on modeling and numerical methods for interest rates, cross currency, hybrid, credit and CVA. Dr. Antonov is a published author for multiple publications in mathematical finance, including RISK magazine and a frequent speaker at financial conferences.
