Pricing of credit default index swap tranches with one-factor heavy-tailed copula models

Dezhong Wang, Svetlozar T. Rachev, Frank J. Fabozzi

Research output: Contribution to journalArticlepeer-review

10 Scopus citations

Abstract

In this paper, we provide two one-factor heavy-tailed copula models for pricing a collateralized debt obligation and credit default index swap tranches: (1) a one-factor double t distribution with fractional degrees of freedom copula model and (2) a one-factor double mixture distribution of t and Gaussian distribution copula model. A time-varying tail-fatness parameter is introduced in each model, allowing one to change the tail-fatness of the copula function continuously. Fitting our model to comprehensive market data, we find that a model with fixed tail-fatness cannot fit market data well over time. The two models that we propose are capable of fitting market data well over time when using a proper time-varying tail-fatness parameter. Moreover, we find that the time-varying tail-fatness parameters change dramatically over a one-year period.

Original languageEnglish
Pages (from-to)201-215
Number of pages15
JournalJournal of Empirical Finance
Volume16
Issue number2
DOIs
StatePublished - Mar 2009

Keywords

  • Collateralized Debt Obligation
  • Credit Default Index Swap
  • Credit Default Index Swap Tranches
  • Credit Default Swap

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