2009/10/14 by Igor Halperin, Halperin, Igor
Economics, Econometrics and Finance · Mathematics · #Computational Finance (q-fin.CP) #Credit Risk and Financial Regulations #FOS: Economics and business #Portfolio Management (q-fin.PM) #Pricing of Securities (q-fin.PR) #Statistical Methods and Inference #Stochastic processes and financial applications #q-fin.CP #q-fin.PM #q-fin.PR
paper · pdf · doi:10.48550/arxiv.0910.2696
40 pages, 10 figures
arxiv created 2009/10/14 · openalex publication_date 2009/10/14 · arxiv updated 2009/12/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
This paper introduces a new semi-parametric approach to the pricing and risk management of bespoke CDO tranches, with a particular attention to bespokes that need to be mapped onto more than one reference portfolio. The only user input in our framework is a multi-factor model (a "prior" model hereafter) for index portfolios, such as CDX.NA.IG or iTraxx Europe, that are chosen as benchmark securities for the pricing of a given bespoke CDO. Parameters of the prior model are fixed, and not tuned to match prices of benchmark index tranches. Instead, our calibration procedure amounts to a proper reweightening of the prior measure using the Minimum Cross Entropy method. As the latter problem reduces to convex optimization in a low dimensional space, our model is computationally efficient. Both the static (one-period) and dynamic versions of the model are presented. The latter can be used for pricing and risk management of more exotic instruments referencing bespoke portfolios, such as forward-starting tranches or tranche options, and for calculation of credit valuation adjustment (CVA) for bespoke tranches.