Chiang, M. H., Fu, H. H., and Wang, S. Y. 2012. The Pricing, Credit Risk Decomposition and Hedging Analysis of CPDOs under the Lévy Jump-Diffusion Model. NTU Management Review, 23 (1): 327-362. https://doi.org/10.6226/NTURM2012.OCT.R12017
Mi-Hsiu Chiang, Associate Professor, Department of Money and Banking, National Chengchi University
Hsin-Hao Fu, Ph.D. Candidate, Department of Money and Banking, National Chengchi University
Sheng-Yuan Wang, Master, Department of Money and Banking, National Chengchi University
Abstract
This research follows Dorn (2010) in assuming that credit index spread resembles a Lévyjump diffusion process, in order to derive the pricing formulae together with the hedging parameters in closed-form for Constant Proportion Collateralized Debt Obligations (CPDOs). By introducing risk measures that are of concerns to credit protection sellers, we analyze the embedded risk characteristics of CPDOs, and propose delta-neutral strategies that are feasible to hedge such products. Our numerical results show that, under a volatile market scenario, CPDOs exhibit low rates in achieving the Target Bond Price, and an increased likelihood of their Cash-out events due to aggravated Shortfalls can provoke substantial losses being incurred to investors. We finalize this research by providing benchmark measures for the proposed hedging strategies under different market scenarios and we discuss the impacts of different hedging frequencies on hedging performances.
Keywords
credit risk Constant Proportion Collaterized Debt Obligations Lévy jumpdiffusion model