Pricing and hedging of CDO-squared tranches by using a one factor Lévy model
Faculty of Sciences. Mathematics and Computer Science
International journal of theoretical and applied finance. - Singapore
, p. 663-685
This paper provides a comparison of the exponential copula Lévy model with the classical Gaussian copula model for the pricing of CDO-squared tranches. Several approximations of the recursive approach are considered: a full Monte Carlo approximation, a multivariate Normal approximation of the joint inner CDO loss distribution and a multivariate Poisson approximation of the joint number of defaults affecting the inner CDOs. More particularly, a sensitivity analysis is carried out for three particular days characterized by a low, medium and high value of the quoted iTraxx and CDX index spreads. Moreover, this paper features a comparison of the exponential Lévy and Gaussian Deltas under the multivariate Normal approximation for a period extended from 20 September 2007 until 13 February 2008. The Deltas are computed with respect to a weighted and unweighted version of the CDS pool as well as with respect to another CDO-squared tranche.