TY - JOUR
T1 - A Poisson Model with Common Shocks for CDO Valuation
JF - The Journal of Fixed Income
SP - 72
LP - 81
DO - 10.3905/jfi.2004.461453
VL - 14
IS - 3
AU - Lee, Chih-Wei
AU - Kuo, Cheng-Kun
AU - Urrutia, Jorge Luis
Y1 - 2004/12/31
UR - http://jfi.pm-research.com/content/14/3/72.abstract
N2 - A collateralized debt obligation is a credit risk product created in tranches from a portfolio of debt instruments. To value tranches, it is critical to model multiple default correlations in order to derive the appropriate loss function. Conditional independence is the usual assumption in this regard, but it ignores meaningful correlated shocks. Models assuming conditional dependence are improvements except that the number of parameters makes model calibration very challenging. A Poisson model with common shocks for derivation of the CDO loss function assumes conditional dependence and reduces the number of model parameters by grouping firms with equal credit ratings. Implementation becomes more efficient, and such a model can correct the tranche mispricing produced by the assumption of conditional independence.
ER -