Pricing and hedging CDO tranches using latent one-factor models: An empirical study

Several latent one-factor portfolio default models are compared regarding their hedging and pricing abilities. Besides many well-known models (Gauss-copula, Archimedean copula, Lévy one-factor model, etc.), a new extension using stochastic correlation is presented. Various delta-hedging approaches are discussed, including hedges against CDS-spread risk, correlation risk, as well as risk that is induced by model parameters. The empirical investigation of the models' hedging and pricing capability is conducted over three market periods (calm, volatile, and distressed) using European iTraxx data.     «

Several latent one-factor portfolio default models are compared regarding their hedging and pricing abilities. Besides many well-known models (Gauss-copula, Archimedean copula, Lévy one-factor model, etc.), a new extension using stochastic correlation is presented. Various delta-hedging approaches are discussed, including hedges against CDS-spread risk, correlation risk, as well as risk that is induced by model parameters. The empirical investigation of the models' hedging and pricing capability...     »