Levy Subordinator Model of Default Dependency

Balakrishna, B S (2010): Levy Subordinator Model of Default Dependency.

Abstract

This article presents a model of default dependency based on Levy subordinator. It is a tractable dynamical model, computationally structured similar to the one-factor Gaussian copula model, providing easy calibration to individual hazard rate curves and efficient pricing with Fast Fourier Transform techniques. The subordinator is an alpha=1/2 stable Levy process, maximally skewed to the right, with its distribution function known in closed form as the Levy distribution. The model provides a reasonable fit to market data with just two parameters to assess dependency risk, a measure of correlation and that of the likelihood of a catastrophe.

• Item Type: MPRA Paper
• Language: English
• Keywords: CDO, Default Risk, Levy Distribution, Levy Subordinator, FFT, Gaussian Copula
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

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