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A STRUCTURAL MODEL FOR CREDIT-EQUITY DERIVATIVES AND BESPOKE CDOS
 

Summary: A STRUCTURAL MODEL FOR CREDIT-EQUITY DERIVATIVES
AND BESPOKE CDOS
CLAUDIO ALBANESE AND ALICIA VIDLER
Abstract. We present a new structural model for single name equity and
credit derivatives which we also correlate across reference names to produce a
model for bespoke synthetic CDOs. The model captures volatility and outlook
risk along with correlation risk for small and for large moves separately. We
show that the model calibrates well to both equity structured products and
credit derivatives. As examples, we discuss a number of single name derivatives
on IBM spanning the credit-equity spectrum and ranging from volatility swaps,
to cliquets, CDS options and CDSs on leveraged loans with pre-payment risk.
We also use the model to price tranches on the investment grade DJ.CDX.IG
index along with tranches on the high yield index DJ.CDX.HY. We show that
the model gives consistent and high precision pricing across all these derivative
asset classes. We show that this can be achieved consistently, with the very
same parameter choices across these diverse derivative assets and making use
of only minor explicit time dependencies.
1. Introduction
Devising a structural model for bespoke CDOs, equity structured products and
the new generation of volatility sensitive credit derivatives is an exercise at reconcil-

  

Source: Albanese, Claudio - Department of Mathematics, King's College London

 

Collections: Mathematics