CDOs in Chains
by Johan de Kock of Fraunhofer ITWM,
January 24, 2007
Abstract: This paper discusses the pricing of CDOs in a Markov chains framework. We show that in general the values of the legs satisfy systems of partial differential equations. In the special case of constant default intensities, one only needs to solve a system of ordinary differential equations, the so-called Kolmogorov differential equations.
Keywords: Markov chains, credit risk, credit derivatives, contagion.