On Models of Stochastic Recovery for Base Correlation

Li, Hui (2009): On Models of Stochastic Recovery for Base Correlation. Unpublished.

Abstract

This paper discusses various ways to add correlated stochastic recovery to the Gaussian Copula base correlation framework for pricing CDOs. Several recent models are extended to more general framework. It is shown that, conditional on the Gaussian systematic factor, negative forward recovery rate may appear in these models. This suggests that current static copula models of correlated default and recovery processes are inherently inconsistent.

• Item Type: MPRA Paper
• Language: English
• Keywords: CDO, Gaussian Copula, Base Correlation, Stochastic Recovery, Correlated Loss Given Default
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing

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