À la Carte of Correlation Models: Which one to choose?

by Harry Zheng of the Imperial College of London

October 19, 2010

Abstract: In this paper we propose a copula contagion mixture model for correlated default times. The model includes the well known factor, copula, and contagion models as its special cases. The key advantage of such a model is that we can study the interaction of different models and their pricing impact. Specifically, we model the marginal default times to follow some contagion intensity processes coupled with copula dependence structure. We apply the total hazard construction method to generate ordered default times and numerically compare the pricing impact of different models on basket CDSs and CDOs in the presence of exponential decay and counterparty risk.

AMS Classification: 60J75, 65C20, 91B28.

Keywords: copula contagion mixture model, exponential decay, counterparty risk, basket CDS and CDO

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