Fine-tuning the Equivalent Strike Framework for Bespoke CDO Pricing

by Moez Mrad of the Crédit Agricole Corporate and Investment Bank, and
Racem Triki of the Crédit Agricole Corporate and Investment Bank

March 30, 2011

Abstract: This paper presents a fine-tuning of some mapping functions used in the Equivalent Strike framework. This new approach provides an equivalent strike that is independent from the index base correlation. This feature is valuable when pricing very junior and senior tranches or when computing index tranches (or index base correlation) sensitivities. Our numerical tests on realistic cases showed that the equivalent correlation provided by this new is pretty close to what is computed with common mapping functions.

JEL Classification: C00, C61, C62.

Keywords: Bespoke CDO pricing, Equivalent Strike framework, Index base correlation extrapolation, Index tranche sensitivities

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