The Implied Copula Approach-Empirical Analysis and Hedging Application
Date Issued
2008
Date
2008
Author(s)
Huang, I-Feng
Abstract
One of the most prominent developments of the financial market in the recent years is the creation of credit contracts, which facilitates the transferring of credit risk through trading directly. Among the products evolving from this idea, the promotion and standardization of Credit Default Swap (CDS), CDS index, and CDO tranche on CDS index highly improve the liquidity of the credit market, and thus make the market quotes more efficient. Currently when a credit derivative is being priced, market makers usually choose the copula function that best fits the market quotes as a standard. However, the chosen function hardly ever achieves to completely describe the dependence structure of the joint default probability. Therefore, if we compute the compound correlations of different index tranches, the results will be showing a correlation smile. In accordance with this issue, JP Morgan, Hull and White (2006) had proposed the base correlation and the implied copula approach respectively to overcome this problem. By observing the relationship between market quotes of CDS index and CDO tranche on CDS index, this study is based on the implied copula approach to find an alternative way of calculating the delta of credit derivatives.
Subjects
Credit Default Swap
CDS Index
CDO tranche on CDS index
Type
thesis
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