Beyond the Gaussian Copula: Stochastic and local correlation
by Xavier Burtschell of BNP Paribas,
Abstract: We consider stochastic correlation models that account for the correlation smile in the pricing of synthetic CDO tranches. These can be viewed as tractable extensions of the one-factor Gaussian copula model. We analyse these models through their conditional default probability distributions.
Keywords: default risk, CDOs, correlation smile, factor copulas, stochastic correlation, local correlation, compound correlation, random factor loadings, large homogeneous portfolio approximations.
Published in: Journal of Credit Risk, Vol. 3, No. 1, (Spring 2007), pp. 31-62.