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LÚvy Base Correlation

by JoŃo Garcia of Dexia Group,
Serge Goossens of Dexia Bank,
Viktoriya Masol of Katholieke Universiteit Leuven & EURANDOM, and
Wim Schoutens of Katholieke Universiteit Leuven

September 4, 2007

Abstract: In this paper we investigate one factor models that extend the classical Gaussian copula model for pricing CDOs. The proposed models are very tractable and perform significantly better than the classical Gaussian copula model. Moreover, we introduce the concept of LÚvy base correlation. The obtained LÚvy base correlation curve is much flatter than the corresponding Gaussian one. This indicates that the models do fit the observed data much better. Additionally, flat base correlation curves are also much more reliable for pricing of bespoke tranches.

Keywords: Base Correlation, CDO, LÚvy Process, Historical Tests, Synthetic CDO Deltas.

Published in: Wilmott Journal, Vol. 1, No. 2, (April 2009), pp. 95-100.

Previously titled: LÚvy Base Correlation Explained

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