Valuation of Forward Starting CDOs

by Ken Jackson of the University of Toronto, and
Wanhe Zhang of the University of Toronto

February 10, 2007

Abstract: A forward starting CDO is a single tranche CDO with a specified premium starting at a specified future time. Pricing and hedging forward starting CDOs has become an active research topic. We present a method for pricing a forward starting CDO by converting it to an equivalent synthetic CDO. The value of the forward starting CDO can then be computed by the well developed methods for pricing the equivalent synthetic one. We illustrate our method using the industry-standard Gaussian-factor-copula model. Numerical results demonstrate the accuracy and efficiency of our method.

JEL Classification: G13.

Keywords: Forward Starting CDOs, Synthetic CDOs, Gaussian Factor Copula, Conditional Forward Default Probability.

Published in: International Journal of Computer Mathematics, Vol. 86, No. 6, (June 2009), pp. 955-963.

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